Investment Risk and the Market Cycle – as Valuations Rise, so too Does Risk

Investment Risk – at Sprung Investment Management, we believe that investment management is about managing risk, not chasing speculative returns. Based on over three decades of experience, we also believe that as markets and valuations rise, risk increases.

investment managing risk pair dice future

Investment risk – managing risk is about one thing: dealing with the future.

Sadly, too many investors believe the opposite: at the nadir of a market cycle they think that risk is extremely high. They want to wait “until things look more certain” before investing. Of course, by the time that happens, stock prices have risen significantly. Today, as equity markets reach new highs, they continue to buy believing that the good times will continue.

Managing risk is about one thing: dealing with the future. No one can predict the future with certainty. Therefore, risk is inescapable. However, we believe that our three-part value investing strategy is the best way to reduce risk and volatility and earn consistent returns over time. Our diligent, patient and opportunistic approach has served our clients well, through good and bad markets:

  • Appraise the intrinsic value of each company over a business cycle;
  • Seek long-term growth of capital by investing in companies that we perceive to be mispriced;
  • Utilize a margin of safety to promote return of capital…not just return on capital.

Why does our value investing approach work? Investment risk arises primarily when investors become excessively optimistic and pay too-high prices for investments. The best way to reduce risk is to buy high quality assets at reasonable prices.

As we discuss in our recent quarterly commentary, we believe that after five years of rising prices, equity valuations are looking somewhat stretched. We are not market timers and do not attempt to predict short-term market movements. However, as conservative investment managers, we think it prudent to take some profits in securities that have substantial capital gains. When markets are going up it takes discipline to increase cash positions. Cash can provide a good option to purchase good investments on any market setback.

Many investors feel that there is no need to question their advisor’s approach if their investments are performing well. Nevertheless, high returns may be the result of a risky investment strategy such as an excessive exposure to an investment class (equities, bonds, or real estate for example,) a single market sector, (here in Canada many investors have significant exposures to the volatile energy and materials sectors.) Ask yourself the following question: how would I feel if the gains I made over the past two or three years were lost in a sudden market downturn next month or next year?

As an investor, you must be vigilant in reviewing the investments you hold. Given your individual time-frame, you may find it prudent to make some adjustments in your portfolio.

Download Our Free Special Report – How to Hunt For Value Stocks. Michael Sprung will share with you 5 stocks set for long-term gains.

Investment Risk – Is Your Stock Broker Acting in Your Best Interest? Read more here>>

Investment Risk – Exchange Traded Funds Expose Investors to Unexpected Risks. Read more here>>

Investment Risk – Risk vs. Return. Read more here>>

Investment Risk – we believe clients are more concerned about losing money than making speculative gains. Like to learn more? Please contact us here>>

The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.

Susan Cain Quiet – Does Your Advisor’s Personality Expose You to Risk?

Does your advisor’s personality expose you to risk? In the new book Quiet, Susan Cain suggests it may.

In 2008, in the wake of the credit crisis and the collapse of Lehman Brothers, the S&P/TSX Composite Index declined by over 30%.  Many Canadian investors were shocked to find that the values of their portfolios had shrunk by significantly more. This shock was compounded by the fact that many investors believed that their advisors had put them in conservative investments. Their expectation was that high quality, conservative investments would be less volatile—i.e. that in a downturn, they would go down less than the market.

susan cain quiet advisor risk

Does your advisor’s personality expose you to risk? In the new book Quiet, Susan Cain suggests it may.

How could this happen? There is a growing body of evidence suggesting that the sort of people most likely to go into the lucrative financial service sales roles are precisely those least suited to judging risk. In the recently published book Quiet, author Susan Cain cites a series of studies that suggest that extroverts tend to be attracted to the high-reward environments of investment deals and trading. More importantly, the studies conclude that these outgoing people also tend to be less effective at balancing opportunity and risk than some of their more introverted peers.

In their defence, investment advisors would likely explain that that their clients expect and even demand that they earn their keep by out-performing market indices. However, in order to do that, they are forced to take on more risk. If a fund out-performs in a rising market, it will likely under-perform in a declining market. Again, that is exactly what many Canadian investors experienced in 2008: while the TSX Composite Index declined by 33%, many supposedly ‘conservative’ large-cap equity funds declined by 40% or more.

Part of the problem is using the S&P/TSX Composite Index as a benchmark to judge the performance of your investments.  The TSX is not an ideal investment yardstick. It simply reflects  the nature of business in Canada. And for better or worse, we are still ‘hewers of wood and drawers of water.’ Resource companies (combining the energy and materials sectors,) comprise about 50% for the market capitalization of the TSX Composite Index. That concentration in the resource sector means that the S&P/TSX Composite Index is highly volatile. For example, as commodity prices rose in 2009, the TSX moved up sharply. When they declined in 2011, the TSX dropped sharply.

“The essence of investment management is the management of risks, not the management of returns.” – Ben Graham

So what should investors do to reduce risk and volatility in their portfolios? Firstly, one should set reasonable expectations for investment returns. Rather than demanding that your investments outperform the market, it is more reasonable to ask that they generate a modest real rate of return, after inflation and management fees. We also believe your best protection is to find an investment manager who meets a ‘fiduciary duty.’ A fiduciary duty is a legal requirement that a manager avoids all conflicts of interest and put the client’s interests first. Investment advisors employed by the big bank-owned brokerages only responsibility is to suggest investments that are ‘suitable’ for their clients—a much lower threshold than a fiduciary duty.  In addition, they are not required to disclose any fees or commissions that they will receive if you buy what they are recommending.

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Does your portfolio contain investments or speculative bets? We are pleased to offer qualified* investors our free portfolio review. It will help you to understand if your portfolio matches your personal risk tolerance. Ask us how>>

*Canadian residents with a minimum $500,000 portfolio.

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