The Importance of Avoiding Unintended Bets in Your Investment Portfolio



Investors are familiar with the benefits of diversification across asset classes within their portfolios. There are also many articles and speeches on how to properly conduct an asset allocation exercise. Yet once the allocations are put in place, how do you make sure that you are getting the exposures you were looking for? And how do you avoid assuming unintended risks?

At the 70th CFA Institute Annual Conference, Robert P. Browne, CFA, CIO at Northern Trust, discussed how asset allocation decisions are made using quantitative methods, while the underlying (active) portfolios are often run by managers from the fundamental school of investing.

Portfolio managers “think [investing] is about being deep and thorough about one name against the other,” Browne said. “I always have to remind them, once you own more than 30 securities, you are no longer an analyst. You are a portfolio manager.”

“With all the quant tools and pressure in the industry, you’d think it’s common knowledge, and yet I continuously see it violated,” Browne lamented. During his presentation, he elaborated on his approach to avoiding unintended bets.

Portfolio Ramifications

Browne started off with a warning to portfolio managers who hide behind a common defense: “Be careful when you say that you are benchmark agnostic.”

“Be conscious what’s driving the risk in your portfolio,” Browne continued. “Don’t tell me you underweight Apple without realizing that you are underweighting the technology sector without buying other tech stocks, or that you are making a size bet, or a bet against trends in consumer electronics. Those are all the implied bets when you underweight the largest name in your universe,” he explained.

Geopolitical Dynamics

The election cycle in the U.S. and Europe, and tensions around the world, have prompted much talk over the past year about geopolitical risk among investors. How can investment professionals help clients focus on what’s relevant for their portfolios?

When it comes to predicting the impact that geopolitical shocks could have on the market, Browne said that “the starting point is important.” His analysis shows that, in a bear market, geopolitical events do tend to make a bad situation worse.

In a bullish market, however, a short-term sell-off is just that — short term. Browne said that in that environment, investors are focused on economic growth, earning, and monetary policy. The market sees through geopolitical risk quickly, and the bull market resumes.

Market Corrections

“It’s important to help clients get comfortable with the inherent volatility of the market,” Browne advised.

“5% corrections happen all the time,” Browne told the audience. In fact, they happen every 50 trading days on average, he explained. Similarly, it takes 167 trading days before a 10% correction, and 635 days before a 20% correction.

FURTHER READING: Factor Investing and Asset Allocation: A Business Cycle Perspective

Browne reminded the audience that we had not seen a 5% correction for 192 days and, similarly, a 10% correction for 286 days or a 20% correction for 2,000 days. He insisted this is not a bearish call, though: “To be chronically bearish on the market is dangerous to your clients’ portfolio and your business.”

Ahead of the session, Browne went into more detail regarding the investment process that he and his team follows in a one-on-one interview conducted in the Virtual Link studio at the conference.

Experience more of the 70th CFA Institute Annual Conference online through the Virtual Link. It’s an insider’s perspective with archived videos of select sessions, exclusive speaker interviews, discussions of current topics, and updates on CFA Institute initiatives.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo courtesy of W. Scott Mitchell

This entry was posted in Investment Topics, Portfolio Management, Risk Management and tagged , , , . Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *