Responsive Risk Management
Attempting to consistently limit devastating loss in a fast moving market environment
When you are a money manager that specializes in protecting capital from large losses (down 30%, 40%, or 50%+), it is imperative that you have a process that moves to cash when risk rises—and moves consistently. Not some of the time, not maybe.
Nearly 30 years ago, WBI built responsive portfolios to actively seek opportunity to capture some of the upside when markets are favorable, but reduce loss when markets hand investors devastating negative returns. The idea was to give investors a conservative approach that they could stick with through full market cycles—both bull and bear markets—without being driven to bail and fail on their investment program as bear market losses became intolerable. That is why our tagline is “Tame the Bear. Run with the Bull.”
As the current bull market cycle eclipses its 10th year, the demand for performance that tracks or outperforms the S&P 500 Index has become one of the most important considerations for investors. Through massive central bank monetary policy intervention, the Federal Reserve and central bankers around the world have distorted this market cycle by reducing volatility and avoiding bear market losses. They have done this to keep the asset bubbles they created intact so that consumers continue spending. After all, consumer spending drives 70% of GDP in the United States.1
After the Financial Crisis, many investors looked to position their portfolios conservatively, and were willing to accept modest returns in exchange for capital protection. A little over 10 years later, investors now have “FOMO” (a.k.a. “Fear Of Missing Out”). This has caused investors to take substantially more risk while chasing returns. In our opinion, the returns already happened and investors are unfortunately looking in the rearview mirror. They should be positioning themselves for what may come. Unfortunately, elongated bull markets can lull investors into thinking investing “looks easy.” Investing is never easy.
Investors do not realize that the illusion of chasing returns is over until bear market losses mount. In the “Returns” chart, you can see that the negative sequence of returns over the first 4 months are greater than the positive returns over the next 4 months.
From September 2018 through year-end, major market indexes fell into correction territory with the S&P 500 posting a loss of 13% and small/mid-cap stocks in the Russell 2000 Index sliding 22%. But investors need to remember that these indexes were down over 19% and 27% respectively from their September high to the low on Christmas Eve. As a result, investors who may have passively bought and held products tracking these indexes would need returns of nearly 25% and over 37% just to get back to even. Due to a post-Christmas rally, the S&P 500 just recovered by mid-April, but SMIDs are still waiting for the returns to get back to even as of April 30, 2019. The next time you hear that the S&P 500 was “only down 4%” for 2018, you can now realize this was after all… just an illusion.2
Performance shown is composite performance which includes both Traditional and Tax-Smart Strategies. Prior to 8/25/2014, with the exception of WBI Bull|Bear Tax-Smart Dividend Retirement, the composite only included accounts invested in a model allocated to individual securities. On 8/25/2014, the composite added a second model of accounts invested in an allocation amongst Affiliated ETFs. The model implemented through the use of individual securities and all iterations of the models implemented through Affiliated ETFs are substantially similar. The Affiliated ETFs do not have performance history of comparable duration; therefore, performance of the models implemented through Affiliated ETFs could have been better or worse over the same period and is not indicative of future performance.
As markets peaked in August and September of 2018, the level of risk increased and downside momentum soon accelerated. WBI’s active risk-management process did exactly what it is designed to do—raise cash to reduce catastrophic loss of capital. In the “Month-End Cash Allocation” chart, it is easy to see WBI’s risk mitigation in action as cash holdings swell in October and again in December of 2018 as the market falls. In addition, with active daily security selection designed to see opportunity, cash was redeployed when positive price trends re-established themselves. Over the last few years, WBI has made significant improvements to both the buy side and the sell side of the firm’s investment process. This has allowed portfolios to get to cash more quickly than ever before and get out of cash faster too.
As with other recent declines, Fed intervention limited a normal bear market (down 20%+) from evolving. By flip-flopping on their rate hike program in late December, the Fed was able to keep the asset bubble intact. The negative market trend reversed course and melted up, with the three major indexes posting a one-day boost of 5%+ the day after Christmas and the market has been moving mostly higher ever since.3 One of the negative side effects of managing risk is being out of position when the market stages a very quick comeback rally. WBI has improved how quickly we can get reinvested from a high cash position. Even with these improvements we want to make sure we don’t get reinvested too quickly and get whipsawed with a second loss should the market rally turn into a head fake.
As we can see from the “Cash Allocation and Monthly Returns” chart, our portfolios moved from a high cash allocation to almost fully invested by the end of January 2019. Historically, it would have taken longer to become invested after a decline of this magnitude. During the month of January, the indexes posted strong returns and WBI’s portfolios trailed as they sought to get reinvested. During the month of February, WBI’s portfolios outperformed the S&P 500 Index, showing off what we feel is our much improved security selection process. In March, equity markets were largely unchanged as volatility increased. Still on tight risk controls, WBI sold positions in an effort to control loss, ending the month slightly down. However, in April, markets rebounded and the strategies ended in positive territory.
Performance shown is composite performance which includes both Traditional and Tax-Smart Strategies. Prior to 8/25/2014, with the exception of WBI Bull|Bear Tax-Smart Dividend Retirement, the composite only included accounts invested in a model allocated to individual securities. On 8/25/2014, the composite added a second model of accounts invested in an allocation amongst Affiliated ETFs. The model implemented through the use of individual securities and all iterations of the models implemented through Affiliated ETFs are substantially similar. The Affiliated ETFs do not have performance history of comparable duration; therefore, performance of the models implemented through Affiliated ETFs could have been better or worse over the same period and is not indicative of future performance. *WBIA, WBIC, WBIE, and WBIG as of 4/30/19. Allocations are subject to change.
Featured in orange on the charts, the WBI Bull|Bear Tax-Smart Dividend Retirement Strategy illustrates the risk and return benefits of a multi-strategy approach combining both passive and active strategies in one portfolio. By allocating 50% of the portfolio to WBI’s always fully-invested passive smart beta fund (ticker: WBIY) and 50% in our actively risk managed ETFs,* we seek to provide more up-market return while still providing capital protection in an effort to reduce catastrophic loss of capital. We believe the Dividend Retirement Strategy is a great alternative for investors seeking more upside without giving up all of their downside protection.
At WBI, we believe it is important to stop chasing returns that may already be in the rearview mirror. Do not succumb to FOMO as the Fed’s accommodative policy has minimized downside risk so far. This has made investing over the last 5 or 6 years look easy… until it isn’t. Taking on more risk to chase returns never makes sense if you end up absorbing large losses. Large losses are very difficult to overcome. We believe we can help you to minimize loss of capital and help you to participate in bull market returns. Over the long run, an approach focused on bear market capital preservation and bull market participation may lead to a successful wealth building investment.
Important Information
Past performance does not guarantee future results. This is not an offer to buy or sell any security. No security or strategy, including those referred to directly or indirectly, is suitable for all accounts or profitable all the time. Performance shown is composite performance which includes both Traditional and Tax-Smart Strategies. The Tax-Smart SMA program accounts are subject to investment risk, including the possible loss of principal. The ETFs in the Tax-Smart SMA program accounts may invest in other ETFs, mutual funds, and Exchange-Traded Notes (ETNs) which will subject the account to related additional expenses of each, and the risk of owning the underlying securities held by each. Investment risks may include but are not limited to: market, economic, political, interest rate, currency exchange, leverage, liquidity, credit quality, model, portfolio turnover, trading, REIT, high yield stocks, non-diversification, concentration, commodities, options, new fund, and client specific restrictions. WBI’s Passive ETFs are not actively managed and WBI does not attempt to take defensive positions in declining markets. You should not assume that any discussion or information provided here serves as a substitute for personalized investment advice from WBI or any other investment professional. If you have questions regarding the applicability of specific issues discussed to your individual situation, please consult with WBI or your chosen professional advisor. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. WBI’s advisory operations, services, and fees are in the Form ADV, available upon request. The allocation to ETFs can provide increased tax efficiency over traditional SMA approaches. We believe the structure of the Tax Smart Program provides several benefits in addition to the potential for increased tax efficiency. However, Clients should understand that tax-qualified accounts, such as IRAs, do not benefit from any additional tax efficiencies of the “Tax-Smart” structure. Please consult with a tax professional prior to making investment decisions.
WBI has an inherent conflict of interest in investing in or recommending Affiliated ETFs as follows: 1) WBI and affiliates receive management fees from Affiliated ETFs. To avoid receiving two layers of management fees in situations where clients invest in Affiliated ETFs through SMA and Platform accounts, WBI will either: (i) waive the management fee at the account level; or (ii) credit the management fees paid by the Affiliated ETFs to WBI and its affiliates with respect to an account’s investments in Affiliated ETFs against the account-level advisory fees the account owes WBI, and 2) WBI’s affiliated broker-dealer, Millington Securities, Inc., receives compensation (including payment for order flow, commissions or other fees) for transactions effected on behalf of Affiliated ETFs. Trades WBI places through Millington will be subject to WBI’s duty of best execution and applicable law.
Net of Fee Performance (NFP) is net of WBI’s investment management fees and includes reinvestment of dividends and other earnings. Net returns reflect the deduction of the highest fee charged. Both NFP and Gross of Fee Performance (GFP) were restated effective February 28, 2017, to reflect the exclusion of management fees paid by the Affiliated ETFs to WBI held through the WBI Tax-Smart SMA program accounts which resulted in understating GFP, and as a result, NFP. Additional information is available upon request.
Benchmark performance does not include deductions of transaction and custodial charges or investment management fees, which would likely reduce performance results. Because the strategy involves active management of a potentially wide range of assets, no widely recognized benchmark is likely to represent performance of any managed account. WBI managed accounts may own assets and follow investment strategies which cause them to differ materially from the composition and performance of the benchmarks shown. Indices are unmanaged and may not be invested in directly.
S&P 500 Index: includes a representative sample of large-cap U.S. companies in leading industries where all cash payouts (dividends) are reinvested automatically. Bloomberg Barclays US Aggregate Bond Index: a component of the US Universal Index and covers the USD‐denominated, investment‐grade, fixed‐rate, taxable bond market of SEC‐registered securities. Russell 2000 Index: measures the performance of small-cap U.S. companies.
Other strategies may have different results.
You are not permitted to publish, transmit, or otherwise reproduce this information, in whole or in part, in any format to any third party without the express written consent of WBI Investments, Inc.
Sources
1 “Consumer Confidence Is at Its Highest Level since 2000.” NBCUniversal News Group, 30 Oct. 2018.
2 Morningstar, Total Return, as of 4/30/2019
3 William Watts and Barbara Kollmeyer. “Dow Soars over 1,000 Points as Stocks Bounce Back from Christmas Eve Meltdown.” MarketWatch, 26 Dec. 2018.