Managing Portfolios for Market Cycle Risk

December 21, 2021

Here at BCM, we put a lot of focus on our All-Weather Balanced allocation. This flagship portfolio broadly holds 60% stocks, 30% bonds and 10% gold.

We also offer, however, a more conservative option as well as a pedal-to-the-metal growth option. The Conservative allocation targets a 40% exposure to stocks, a 50% exposure to bonds and a 10% exposure to gold. BCM Growth is simply all stocks.

Long time clients will recall that here at BCM, our origins were built on an investment structure that included a discipline for evaluating potential market risk as we moved through the economic and market cycle. While most of the time our allocation alone effectively has managed that risk, there have been occasions where larger macro forces have overwhelmed that allocation and raised risk to levels we have found to be potentially detrimental. When this environment has been present, our solution has been to make portfolio adjustments within our balanced accounts, reducing our stock holdings to a more conservative 40%.

This has not been a focal point in client conversations, because frankly such adjustments are rarely made. But, when necessary, we make them. In fact, if you’ll look at our All-Weather Balanced fact sheet (QTLY Performance) you’ll see in the Allocation Framework box, we note a 20% tactical sleeve for stocks and a 20% tactical sleeve for bonds.

Regarding our Conservative and Growth allocations, we do not make portfolio adjustments based on our risk outlook because, well…, Conservative is already just that. As for Growth, it is not designed for the risk averse, but for those who have a very long-term horizon and for whom immediate risk control is not a concern.

We’ve said over and over that we do not believe in forecasts of any sort, nor do we ever try to short-term time the market. We believe that the former is useless and the latter not possible, outside of a lucky hit. That viewpoint creates an obvious tension with our All-Weather Balanced risk management approach. It is Howard Marks (Chair and founder of Oaktree Capital) who reconciled that tension far better that I ever could in a recent talk.

The Distinction between Managing for the Market Cycle and Market Timing.

“Market timing is raising or lowering cash based on a prediction of what the market is going to do. This is something we don’t do. We NEVER make a prediction of what the market’s going to do, as we do not believe in forecasting.

Having said that, not knowing where we are going doesn’t mean that we can’t have an idea of where we are. We can, and we do. Our investment allocation decisions are based on our assessment of where we are in the economic and market cycle.

It’s important to recognize that having an idea of where we are within the market cycle DOES NOT tell us what’s going to happen tomorrow. From any point within the cycle, the market can go up, down or flat. The fact that markets may be overpriced doesn’t mean that they are going down tomorrow, any more than the fact that they may be underpriced means that they are going up tomorrow.

It is where we are in the market cycle that determines the odds, or tendencies of future longer-term market moves. And so, by understanding where we are, we can get the odds on our side, understanding that there is never perfect certainty that our forward assessment of market risk will be exactly right.

So, the distinction between managing risk within the changing market cycle and market timing is this – managing for the cycle means that we are tilting our portfolios and behavior to match our assessment of cycle-based market risk, as opposed to raising or lowering cash based on predictions or guesses of what’s going to happen say, tomorrow.”

If you have any questions, please give us a call.