What I am about to suggest could very well revolutionize portfolio management. In the current market environment—an environment in which one needs to prepare for both the journey and the destination—portfolio strategy and structuring needs to be addressed from a different perspective. The essence of portfolio strategy, for the time being, is this: allow yourself room for error while outperforming absolute and relative benchmarks. Of course, outperformance is, and always will be, a goal of any portfolio manager. However, delivering consistent returns month after month is more critical. This is the foundation for diversification. Thoughts regarding the relevancy of diversification in the current market environment to follow at a later date.
On September 1, 2010, domestic equity markets traversed an exponential trajectory upward. The S&P 500 Index touched as high as +3.05% from its prior close. This has performance implications for both long- and short-exposure portfolios. But should it have strategy implications as well? A day like this should allow for, not force, a portfolio manager to reevaluate positioning.
The problem with these types of daily returns—as they relate to portfolio structuring—is that they either strongly confirm or strongly reject your positioning. They create an emotional factor that did not exist when you designed your portfolio. If you have established some room for error, you can reduce that risk.
With all the talk of negative feedback cycles, I’m going to leave you with a positive feedback cycle: consistency produces outperformance in a volatile period which, in turn, reduces the emotional risk, allowing for objective analysis.
Assuming the analysis is good and the goal is consistency, you can continue to follow this loop.