3 novembre 2015

English Box

Defensive Boxing

Investors would do well to beware of portfolios with high beta but no alpha – according to Gregory Kolb of Perkins Investment Management – as being bullish in a bull market is neither skillful nor financially healthy

Defensive Boxing

The stock market has landed a punch in recent months. As we assess the damage and consider what might come next, let us also consider our style. Legendary boxing manager Cus D’Amato – trainer of multiple world champions including Mike Tyson, and credited with developing the so-called peek-a-boo style of boxing – is said to have once noted that if “You don’t get hit, you don’t lose. It’s as simple as that. Once you learn to stay low and tuck behind your gloves, in constant motion, no one is gonna be able to land nothing”. It is fairly clear why defensive technique is important in the ring. Boxing is a brutal sport.
Similarly, suffering steep losses in your investment portfolio can be the equivalent of a knockout blow from which it is very hard to recover. Seasoned investors will recall from prior downturns that throwing in the towel and selling amid a significant market decline becomes a strong temptation for many market participants. Getting back up on your feet and recouping losses can be nearly impossible.
As indicated in the chart below, with a greater loss, an exponentially greater gain is required to get back to “par.” Avoiding getting hit in the first place, as D’Amato put it, is crucial to “winning the fight” – compounding wealth and purchasing power over a long-term financial planning horizon.

How to avoid losses

The peek-a-boo boxing style involves consistently moving the head to a new spot, and the avoidance of short or well-known patterns. In this way, the boxer makes it difficult for an opponent to hit him.
Avoiding losses in common stock investments involves a distinctive technique as well. Losses typically involve weaker-than-expected earnings, a balance sheet challenge, or a reduced valuation multiple. Additionally, excessive concentration (often unintended) in risk exposures can cause a portfolio pain. Thus, an investing style which involves a focused effort to avoid these “hits” forms the basis of a defensive stance in the ring of the stock market.
In this era of Fitbits and activity tracking, there are a variety of ways for investors in both active and passive funds to assess the “health” of their portfolios. Strategies with a good command of defensive technique are designed to achieve relatively low standard deviation, beta and down capture ratios. While none of these metrics on its own will tell you for certain that a portfolio is especially exposed to a market punch, taken together they can indicate historical vulnerability (or resistance to) a drawdown in a useful way.

Defensive Boxing

Gain Needed to Recoup Potential Loss of X% [A portfolio which begins with $1,000 and suffers a 30% loss down to $700 needs a gain of $300 to return to the starting value of $1,000. This $300 gain represents 43% of
the $700 post-loss portfolio. The hypothetical example does not represent the returns
of any particular investment]

Your doctor would likely frown at a diet too high in sugars and fats, enjoyable as those meals and treats may be. Similarly, investors would do well to beware of portfolios with high beta but no alpha, as being bullish in a bull market is neither skillful nor financially healthy.
You may say that, yes, it is fairly obvious that you don’t want to be knocked out in your investing portfolio, tell me something I don’t know. Well, there is a second, more nuanced reason for emphasizing defensive technique. In the peek-a-boo style, it is called “slip and counter”. Once a boxer has avoided a punch, he is to counter with a punch of his own while the opponent is still open. D’Amato’s fighters were among the most ferocious of all time, in part due to the aggressive counterattacks they mounted. In the investing arena, it is crucial that the defensively positioned investor, once a risk has been largely avoided, is able to capitalize on the opportunities presented by the sell-off.

Looking to “counterpunch”

The CBOE Volatility Index recently reached the highest level since 2011. Primary investor concerns include economic and stock market weakness in China, and uncertainty surrounding the U.S. Federal Reserve’s interest rate policy (i.e., Will they hike?, and Will the U.S. dollar continue its rise?) As a result, stocks exposed to the so-called commodity super-cycle and higher interest rates (and by extension a stronger dollar) have in many cases been hit hard. These are the areas within the market where our analysts and portfolio managers at Perkins are looking to “counterpunch”.
As we assess these areas of weakness, we are mindful of the difficulty in gaining an “edge” in predicting commodity prices such as crude oil or iron ore. In these situations, overly leveraged balance sheets may prove to be the end for many companies, at least in their current form.
At the same time, we are finding interesting opportunities in companies which have segments impacted by China and commodities, but also have other operations which can cushion the blow or competitive positions which can withstand the current difficulties and eventually prosper again.
In addition, we believe many of the U.S. blue chip companies (across the market cap spectrum) which have been negatively impacted by the stronger dollar represent good buys at current prices.
More broadly, stock valuations remain stretched, and complacency regarding easy money – which has been building for over six years now – is unlikely to recede all at once.
Thank you for your continued confidence in Perkins. As we head into the busy year-end period, a final instruction from the great trainer: “Keep that chin tucked down. And your eyes looking up and out”.

Gregory Kolb, chief Investment officer, portfolio manager, Perkins Investment Management (Janus Capital Group)

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