Brexit Stress and the Benefits of Portfolio Balance
By Andrew Dassori
“Rome was not built in one day.”
– John Heywood, c. 1538
…and for investors, one day of performance should never be relied upon as statistically significant. Just two days after launching Longwave Advisor, however, markets experienced an unexpected shock when on Thursday, June 23rd, the United Kingdom voted to leave the European Union. While Friday’s fallout is merely a blip in the long-term history of markets, it provides a useful datapoint in explaining how our approach is different from that of other digital wealth managers, as we weathered the storm by design.
Figure 1: Aggressive Portfolio Performance on 6/24/2016
A key difference between our investment process and others is that we begin with balance, budgeting risk evenly across economic scenarios that cannot be predicted consistently.¹ These involve changing expectations for growth and inflation. We don’t want to be a gambler here and would rather be the house.
Other strategies consistently bet on economic conditions. Modern Portfolio Theory, for example, is structurally tied to growth. A traditional mix of 60% stocks and 40% bonds may look diversified as a dollar allocation, but in reality this portfolio’s performance is driven by stocks as they make up close to 90% of the risk.
Figure 2: Dollar vs. Risk Allocations
These portfolios make an implicit bet on growth because stocks outperform when growth rises. So when economic conditions fall below expectations, this bet is less likely to pay off.
Results here are most plainly visible on days like Friday, when expectations for growth fall due to an unexpected event. In our opinion events like this aren’t worth risking a client’s savings on, so our approach is different – and at least on Friday, so were the results.
With this please remember the limitations of a single datapoint when investing over the long-term. The experience, however, has been nonetheless useful in showing why we build portfolios a different way.
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¹ “How to Drown in Three Feet of Water,” The Signal and the Noise, by Nate Silver, pg. 176-203. New York: 2012.
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