Oil price shocks and a revisit of deflationary concerns in Europe are just some of the “gifts” the New Year has brought in 2015 to increase volatility in global financial markets. The concern for financial advisors is that loss of invested capital may come with volatility if there is a need or a client decision to sell. For those U.S.-based financial advisors already skeptical about the strength and stamina of the U.S. equity bull market, some now perceive a fork in the road. They can continue down the path of diversification, or they can explore a path of adopting more proactive and potentially more costly risk management as a means of preventing loss.
Whether a financial advisor needs to do more than adequately diversify client portfolios is a subject of debate within the advisor community. At the emotional heart of the debate is the question, “How much can your clients bear to lose?”
Some financial advisors have a “memory” from the last recession that diversification, or asset allocation failed. How strong that memory of failure is may depend on how heavily their portfolio was tilted to U.S. large-cap equities or other risky assets during the time of the recession. Citing data and analysis from Sam Stovall, U.S. Equity Strategist at S&P Capital IQ:
The Bear Market Price percentage decline of the S&P 500® in 2007-2009 was much worse than average at -57% (Sam found the average price decline of the S&P 500 during Bear Markets to be -38%, going back to September 1929)
- Every sector of the S&P 500 experienced a decline in 2007-2009
- Isolating 2008, nearly all asset classes experienced declines; with the Barclay’s Aggregate (+5.2%) and Long Treasuries (+24.0%) being two notable exceptions
Importantly, and seemingly in contrast to a view that diversification “failed,” Sam found that a 60/40 portfolio (S&P 500/Long Term Treasury Bonds) returned -12.6% over this same period of time in 2007-2009. While this piece of Sam’s data and analysis is from a very thorough presentation, Sam has said that “…maybe it is our memory that failed us and not diversification.” Or it could be that even a loss of 12.6% is too much loss for some financial advisors.