By David R. Guttery, RFC, RFS, CAM
President, Keystone Financial Group-Trussville
Let me preface my comments by saying that actionable investment advice can only be rendered following a comprehensive planning effort through which objectives are identified, risk tolerance is defined, and a basis for investment direction is determined.
At a high level, I believe there are three platform level strategies that could help offset market volatility at this time, and I’ll discuss each strategy individually. The first strategy is to own a greater weighting in stocks of companies that produce economically durable products and services. Second, I would explore the alternative universe to general securities, to seek negative correlation with the market, and for the pursuit of income. Third, I would defensively employ the use of market options, and options strategies.
Again, I would strongly suggest that anyone having an interest in what we’re about to cover should consult with their investment professional before employing risk mitigation strategies.
Think of an economically durable commodity as being something consumed on a consistent basis throughout changing economic cycles. In general, this would include basic food staple items, basic pharmaceuticals, utilities, and other similar items. Very often, tobacco and alcohol prove to be very durable staples during periods of economic softness.
I am looking for companies that manufacture products, that will be consumed durably, that I can obtain with a very low forward price to earnings multiple, that will also provide a nice dividend back into the portfolio. During times of enhanced market volatility, I have placed a great value on steady, dependable streams of dividend income. The dividend yield can change obviously, depending on the price for which the stock was purchased. That income, over time, provides stability to the portfolio as markets reprice the risk of changing economic conditions.
In addition to dividend income from equities, I would also suggest that sleeves of fixed income also be evaluated for credit worthiness, and sector exposure. With the Federal Reserve in quantitative tightening mode, I believe that the risk of corporate issues, on a shorter-term basis, with higher credits of quality, could offer greater buoyancy to a portfolio than could be found with treasuries. Indeed, treasuries seem to be much more volatile, based in part, because the Federal Reserve had previously been the single largest central purchaser of those issues, with printed money, over the last two years.
Today, the Federal Reserve is no longer that largest single purchaser of a US treasury debt, and, there has been a great amount of price distortion resulting from the expansion of the Federal Reserve balance sheet. To that end, for the first time in 50 years, treasuries and equities are moving in a positively correlated way. I would seek to generate income from debt securities, from sources outside of government issues for this reason.
Typically, when we talk about alternative investments, it generally refers to such instruments as market linked certificates of deposit, real estate investment trusts, limited partnerships, and structured notes, among other things. Keep in mind that all investments carry risk, including loss of principal. Market-linked CDs are not FDIC insured. These products are complex and may not be appropriate for all investors. When I have employed alternatives such as these, it has been in an effort to streamline portfolio holdings, and to build a bridge if you will between dedicated fixed interest positions, and variable equity positions. These can offer unique sources of negative correlation, income, and hedges against market volatility.
However, I would also include other tools in this category. Certain types of life insurance for example, can offer guarantees of principal, and tax-sheltered interest. Very often, we look to an instrument that we need anyway, for indemnification, and sometimes long-term care, for a third use as an external complement to what we maintain in fixed interest securities. Think of it as an external, quasi bond sleeve if you will. Sometimes people overlook the tax preferential characteristics of life insurance, and it never occurs to them that such could also offer a principally guaranteed offset when viewed holistically. I would also suggest that equity indexed annuities could serve a similar role, if there is no need for the life insurance tool.
This is just a summary list of many alternatives that could be employed at this time to offset risk. I strongly encourage you to consult with your individual financial professional to determine the suitability of any of these options within your objective driven portfolios.
Market options are instruments that allow someone to control shares of an underlying stock. A call option provides the ability to purchase a given number of shares, for a predetermined price, over a specific period of time. A put option provides the ability to sell shares, at a predetermined price, over a specific period of time. Again, a very high-level example here, but if someone purchased shares of ABC company, but wanted to limit their downside risk, then we could purchase a put option, with a strike price that reflected a 15% floor. If the underlying stock dropped below the 15% threshold, then the put option could be exercised to sell that stock at the predetermined price, where the 15% barrier was established.
So, in closing, we’ve often talked about planning being first, with execution being second. Objective driven investment plans should be governed by a holistic financial plan, and remaining true to that plan should be the over arching goal. Having said that, many people have recently asked about methods for addressing risk at the execution level, and I hope this high-level overview is helpful. Again, I encourage you to engage your professional financial planner or investment advisor about what might be suitable and uniquely appropriate for your situation.
David R. Guttery, RFC, RFS, CAM, is a financial advisor, and has been in practice for 31 years, and is the President of Keystone Financial Group in Trussville. David offers products and services using the following business names: Keystone Financial Group – insurance and financial services | Ameritas Investment Company, LLC (AIC), Member FINRA / SIPC – securities and investments | Ameritas Advisory Services – investment advisory services. AIC and AAS are not affiliated with Keystone Financial Group. Information provided is gathered from sources believed to be reliable; However, we cannot guarantee their accuracy. This information should not be interpreted as a recommendation to buy or sell any security. Past performance is not an indicator of future results.