The use of portfolio diversifiers was written about often during the last bear market and now after a five year rally for stocks the discussion is ramping up again. This past weekend Barron’s Fund of Information column explored the use of hedge funds by members of congress as portfolio diversifiers, joking that this might be the only thing that democrats and republicans can agree on.
While no one can know with any certainty when the next large decline is coming we do know that at some point as a function of normal market behavior there will be another very large decline and it will again scare the hell out of clients. And when that occurs, clients will be looking to their advisors to try to protect their portfolios from the full brunt of that large decline.
In general terms, a time to consider increasing exposure to portfolio diversifiers would be after a huge rally in the market. More specifically, a time to consider adding or increasing exposure to portfolio diversifiers would be when the equity market shows signs of price deterioration or a slow rolling over of prices.
Bear markets historically have started slowly over a period of several months not with crashes. Take a look at where the S&P 500 was six months after their respective 2000 and 2007 peaks.
According to Yahoo Finance, the S&P 500 was only down 5% six months after its peak in 2000 and six months after the 2007 peak it was only down 7.7%. After almost five years of market gains it makes sense to start thinking about slowly adding in portfolio diversifiers. Things like gold and hedge fund replicators have helped in the past but of course that is no guarantee they will work in the future but whenever the market does roll over again advisors will want their clients’ portfolios to look less like the stock market than it should have in the last few years.
This article was written by AdvisorShares ETF Strategist Roger Nusbaum.