How to manage investment risk as we head back to the future
A stimulated economy is doing OK but may still stumble, says a U.S. advisory that shows how to manage risk in a conservative portfolio.
We’ve been here before.
Once again the economy is getting a push from government spending and quantitative easing and low interest rates.
For the most part, stock markets have responded well. They have been rocked by more than one crisis, but always seem to snap back.
Yet what happens when conditions change? When governments turn off the tap, when easing eases off and interest rates rise?
One U.S. editor who can be counted on to take a cautious stance is about as optimistic as he’s been for several years.
But this is no time for investors to let down their guards. The primary goal is still to manage risk, says Bob Carlson’s Retirement Watch.
The economy in North America and abroad is doing well so far in 2011. But we cannot assume this will last throughout the year, says Mr. Carlson. We are still paying down the bill from the long financial crisis.
Before we start considering the items on that bill, we will see exactly how this editor is dealing with risk and reward in the markets as we update his Retirement Paycheck Portfolio.
The best performer
Mr. Carlson’s retirement portfolio (one of several on which he keeps his readers informed) is made up largely of U.S. funds that are not likely to find their way into Canadian portfolios.
Yet the conservative strategy they represent knows no borders.
For one thing, while many bond investors “were generally hammered” in the last quarter of 2010, this portfolio avoided the damage. In fact, it closed out 2010 as the best performer among his portfolios, returning almost 10 per cent.
“This portfolio is designed to yield about 6%. It takes more risk than conservative bond portfolios to achieve this yield. But the portfolio is diversified with assets that do well in different economic environments, isn’t tied to interest rate the way most income portfolios are, and we manage it with sell signals and changes at other appropriate times.”
For example, DoubleLine Total Return Bond (DBLTX) “earned far more than the S&P 500 with far less risk and volatility.” It returned over 16 per cent through 2010 and has been yielding over 12 per cent this year. Its manager, Mr. Jeff Gundlach, is particularly adept at reading mortgage markets and plucking mortgage securities at appealing discounts.
The editor also has a conservative high yield bond fund, Harbor High Yield Bond (HYFIX). “Its philosophy is to preserve capital first and seek high yields and capital gains as secondary goals.”
The portfolio has been getting big gains from Gabelli Global Gold, Natural Resources and Income Trust (AMEX-GGN), a closed-end fund that owns stocks of gold miners and other resource firms. Recent share price gains cut its yield to less than 9 per cent, but the fund returned over 30 per cent in 2010.
Tortoise Energy (NYSE-TYY) has been riding the boom in commodities. Tortoise holds shares of master limited partnerships, mostly pipelines. It returned 28 per cent in 2010 and yields 5.6 per cent. It also trades at a premium to its net asset value, which makes the editor cautious. He has a sell signal at $25.50, with the current price at $28.57.
Another gold investment is iShares COMEX Gold Trust (AMEX-IAU). There is a more popular gold bullion ETF, the editor says, but this trust “offers lower expenses and investors are starting to see its benefits.” It’s at $13.99.
Kicking the can
U.S. investors are clearly taking more risk, says Mr. Carlson. They believe the government and Federal Reserve Board will keep things going. “Also the Fed is forcing people to take risk by keeping short-term interest rates painfully low.”
The editor anticipates the developments ahead for the rest of the year.
Economic growth in the U.S. is now above average and should keep that pace through the first half of the year. Growth in Asia, especially China, remains much higher.
Private credit growth appears to be returning in the U.S. It’s nowhere near the “robust levels” of the boom, but it’s enough to help the economy.
Unemployment in America remains high and hiring is slow. The rate of unemployment will decline slowly, keeping wage growth modest.
There’s also a push-me-pull-me effect with “tension between all the unused capacity in the economy keeping a lid on prices and strong global demand pushing prices higher.”
China and other Asian countries are taking steps to reduce growth, stem inflation and deflate bubbles. But these steps are modest and are having little effect. The bubbles will be a worry throughout the year.
On the other side of the world, the European debt crisis is still a problem as authorities “simply keep kicking the can down the road.”
Meanwhile, large U.S. businesses have a lot of cash and good balance sheets. If there is sustained growth, we could see more takeovers, more dividends and perhaps even more hiring.
He concludes with two less optimistic projections. “Growth in the U.S. should slow after the first half of 2011 when the effects of the latest stimulus efforts fade.”
And the U.S. dollar will do poorly against hard assets and currencies of nations in better fiscal condition.
“In summary, we have another credit and stimulus-induced economic and market surge.”
As we reach the middle of the year, notes Mr. Carlson, uncertainty will raise its head again “unless it is clear that credit growth is growing and businesses are starting to hire.”
The economy is still not back to where it was before the credit crisis struck three years ago. And it will be years before most of the wheels and pulleys of the economy return to their peaks, warns the editor.
“We’re a bit more optimistic but still cautious and focused on risk management.” In short, this is no time for investors to take either the good or the bad for granted.
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