Bear Proofing Your Future

Summer 2001 CSANews Issue 39  |  Posted date : Mar 09, 2007.Back to list

Over the years, we have heard all the cliches about investment strategy, such as asset allocation, diversification, buy & hold, etc.

We now know that asset allocation (how your assets are divided among equities, bonds and cash) is not a risk-reduction strategy or even a return-enhancement approach. It has failed abysmally in all of these areas since it was first touted 10 years ago.

As it was based on a single strategy used by pension funds and explains only the variance in the performance of a portfolio, it should never have been extended to consumer-based finance as a core truism, which it is not.

We now know that it is equity allocation, how your assets are divided among different types and sectors of equities, that determines much of risk and return. Bonds and cash seem to move together in unison, while a balanced portfolio based on cash-strong value stocks seems to be far more resistant to loss than all other approaches.

Diversification has also fared poorly as many investors took a one-of-each hot fund and hottest stock approach. We learned that about eight­10 stocks or two-three mutual funds give adequate diversification if properly selected by industry sector and, once again, on low debt, cash risk and low P/E stocks.

International diversification by country proved to be of higher risk, as most great firms and important holdings are transnational, earning income in many countries. Most Asian, South and Central American and emerging markets have produced no return over five, 10 and 15-year analyses ­ adding to losses and risk. Less can, in fact, produce more.

Leverage, using other people's money to get a higher return on poor-performing assets such as your home, has produced largely disastrous losses and real estate has out-produced the return of most sectors. Margin calls and huge losses enforced the concept that leverage can increase risk exponentially and low interest rates reduce the tax advantage of borrowing.

Bear proofing a portfolio, however, does not mean a wholesale retreat into cash and triple-A bonds. The money market returns continue to decline as interest rates fall. Capital-assured rates and trusts, income trusts, real estate trusts, managed yield funds, guaranteed investment funds, and even the highly expensive segregated funds in a few situations, can all add better risk management, tax efficiency and diversification in a portfolio, along with the use of flow-through shares.

While not without some risk, a number of the options called Alternatives Investment Products (AIPs), now including hedge funds, are rarely used by the middle market investors. AIPs can be market neutral and can produce tax-efficient gains. In some cases capital is guaranteed and, in most, the returns are taxed as capital gains at the lowest rates ­ creating both tax efficiency and risk management.

Professional advice from an innovative, forward-looking non-cliche- based advisor is important, as is reading all prospectuses, carefully doing proper homework and, of course, a total portfolio review as to future risk and tax risk. This is true "Bear Proofing" of your assets using new ideas, AIPs and re-education as the basis of this approach. Why, because only your future wealth can be altered, not your past, and not by making decisions based on the past.