By Jerry Wagner
I love to meet with clients. Like the bite of a cold wind on a frosty November morning in the Midwest, a meeting with a client can bring an adviser back to the concerns of actual people trying to survive in a real economy.
While I spend a lot of time dealing with real issues in running an organization of over 90 service providers, I also spend a great deal of “ivory tower time” creating and improving the investment strategies and portfolios that we offer to advisers and their clients.
Creating a portfolio for a client requires gathering information from them. We do this with our suitability questionnaire. Clients complete this questionnaire, documenting information about their ability to take risk, attitude or sensitivity toward risk, and time horizon, all of which can determine the appropriateness of a given strategy.
I usually recommend a portfolio divided between both “core” (60%–65%) and “explore” (35%–40%) components.
In my view, the core portion represents the “beta” part of the portfolio—the portion that attempts to capture the return characteristics of various asset classes. It is very important that a portfolio seek to capture these returns in order to keep up with the returns of the appropriate strategy benchmark.
Each core portfolio Flexible Plan Investments (FPI) offers is designed to represent one of five risk profiles: Conservative, Moderate, Balanced, Growth, and Aggressive. And each FPI core portfolio employs our brand of dynamic risk management.
With the explore portion of the portfolio, our goal is to provide “alpha”—excess return for the risk taken. We also seek to address specific concerns or extra exposures that the client may be interested in achieving.
While advisers and clients can construct core-and-explore portfolios from the many FPI strategies available, we have also created two “easy button” investment options that do all of this hard work for you: (1) Our QFC Multi-Strategy Core and Explore turnkey strategies, which give investors a choice of the percentage of their investment to place within the core and explore categories. (2) Our QFC Fusion 2.0 strategy—offering combined core-and-explore, suitability-based portfolios.
Of course, creating a dynamic, risk-managed strategy for an investor and then presenting it in a way that is easily understood requires time, skill, and some artfulness. Advisers do not take this task lightly. Yet despite all of the time and effort expended, inevitably in the course of the conversation that ensues immediately after the presentation, more times than not, I hear …
“But what if …?”
In this economic environment, that “what if” could be rising inflation, increasing volatility, falling markets, soaring interest rates, or many other concerns. Most clients are very informed about current events, especially the stresses and strains of the economy. They see these play out before them at the grocery store, the gas station, and in their credit card statements and mortgage applications—and this doesn’t even include what they see on the evening and financial news shows. All of these experiences give rise to genuine concerns.
In a previous article, I answered the question investors often ask when faced with the uncertainty of the present economic and political environment, “When should I invest?” I demonstrated how, with the “antifragile” strategies offered by FPI, the answer to the question should be, “Now.” And I showed how one FPI investor tool, the Crash Test Report, provides an objective way of confirming that answer.
The Crash Test Report is one of two reports available to advisers in our Crash Test Analyzer. Our Crash Test Analyzer is different from other products created to determine possible performance during adverse market periods. Other products use either scenario models to project what a strategy will do in, say, a spike in interest rates, or a brief period of actual market data to project the same thing. Our Crash Test Analyzer uses actual historical market data for the period selected, in addition to both the research report and model performance for those exact same periods, to report performance during the adverse event.
As I said, the previous article used the Crash Test Report to answer the question, “When should I invest?” A second report in the Crash Test Analyzer, the Regime Strategy Ranking Report, is designed to help answer the question, “But what if …?”
Finding answers to the “what ifs”
Our QFC Multi-Strategy Explore portfolios allow advisers and their clients to address some of their “what if” concerns with Low Volatility and Low Correlation portfolios, as well as different risk-managed ways of accessing the equity markets with Special Equity and Equity Trends portfolios.
While the QFC Multi-Strategy Explore offerings target each of these areas generally, they do so with a diversified portfolio of strategies. Since they are diversified into multiple dynamic, risk-managed strategies, this is probably enough for most clients. After all, it is usually better to have a quiver filled with arrows than a single arrow when confronting a perceived danger.
Still, if an investor has a specific concern (“But what if …?”), FPI provides a tool to identify which of our scores of dynamic, risk-managed strategies best targets that concern. With the Regime Strategy Ranking Report, advisers can choose the regime stage that represents an investor’s specific concern and receive a report that lists the best FPI strategy to address that concern from the perspective of return, risk, drawdown, or risk-adjusted return based on our research or model performance reports.
For example, one of the fears I’m hearing about lately is the very real possibility of our economy slipping into stagflation next year. Stagflation is one of the most feared stages of an economy. It means that inflation is rising and the economy (as measured by gross domestic product, or GDP) is declining.
If we check in with our Crash Test Report (below), we see that the S&P 500’s compound annual growth rate (CAGR) during such periods has been -14.55% with a maximum loss of 32.04%. Since 2002, stagflation has occurred only 8.1% of the time.
We have now passed the 400-day mark of rising inflation following a 12-month low as measured by the Bloomberg Commodity Index. In the past, that has meant at least eight more months, and up to a year and a half, of additional rising inflation. Many economists are predicting a continued slowdown in our GDP growth rate in the next four quarters. Some suggest that the GDP may actually decline. If they are right, that would signal a bout of stagflation for the economy.
When we look at our Crash Test Report (which is based on Flexible Plan hypothetical research report performance), we find that the QFC Fusion 2.0 Growth strategy we discussed in my previous article did relatively well during times of stagflation. The strategy gained ground with a CAGR of 9.61%. That should not be a surprise. As we discovered in our last discussion, the QFC Fusion 2.0 strategy is relatively “antifragile.”
For those who believe that stagflation is a possibility, or just want to seek some added protection if it comes to pass, a quick check of the other report available in our Crash Test Analyzer, the Regime Strategy Ranking Report, can provide some guidance. It generates a list of the top 10 performers based on our hypothetical research reports for any Crash Test regime chosen. It breaks this out on four separate performance metrics: CAGR, risk (standard deviation), maximum loss, and risk-adjusted return (Sharpe).
With the Regime Strategy Ranking Report tool, we can select from a list of 30 different regime stages covered by our Crash Test Analyzer. Selecting stagflation from the list, we can review all of the strategies on our Strategic Solutions platform for occurrences of stagflation during the last, say, 15 years. Running this selection, advisers will find that the top-performing strategy was WP Aggressive, which had a CAGR of 39.31% (based on Flexible Plan hypothetical research report performance).
The best QFC strategy was QFC Pattern Recognition, which had a CAGR of 30.52% (based on Flexible Plan hypothetical research report performance) during stagflation. QFC strategies also offer lower advisory fees billed to the client. In fact, on accounts over $150,000, the FPI portion of the fee is entirely waived! The fee waiver is also available on accounts that have at least $100,000 invested in QFC Multi-Strategy turnkey programs, such as QFC Fusion 2.0.
Having determined that QFC Pattern Recognition addresses the concern about stagflation, we can easily see the effect of the addition of, say, 10% QFC Pattern Recognition to a portfolio containing QFC Fusion 2.0 as the core and explore portions of the portfolio in our Illustration Generator. The result: During stagflation, the returns would be about 3% better with 0.5% less maximum loss.
Consistent with its antifragile nature, the QFC Fusion 2.0 Growth strategy does a good job of being prepared for any market, even stagflation. With the Regime Strategy Ranking Report tool, we find that, while there is improvement, even if we choose one of the best-performing strategies during stagflation, it’s hard to improve on QFC Fusion 2.0’s results all by itself.
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Wondering “but what if” … rates rise? … bonds drop? … the stock market crashes? … volatility soars? Flexible Plan provides the tools to quickly find the answer to these questions … but only for investors using our dynamic, risk-managed strategies.
