If you make a practice of holding individual stocks with the hope of hitting a home run, but in insufficient numbers to adequately diversify, MPT states that you will not be compensated for the extra risk you are taking. Well-diversified portfolios produce the least risk for any given level of gain. The expected return and degree of risk is defined by the types and relationship of the assets held in the portfolio. There is little to be gained from “stock-picking”, other than additional risk. Asset selection and composition are all important.  

Reducing Risk Through Asset Allocation Adjustment

Because LFM&P’s investment approach is client goal-centered, a primary emphasis is reducing risk and volatility. If you are planning to achieve a particular financial goal, like retirement, at a particular time, or to withdraw funds from a portfolio, reducing variability and increasing predictability of results is a primary objective.

LFM&P’s MarketAware^SM approach seeks to manage your investment risk by adjusting your asset allocation. Reducing your portfolio risk during times when stock prices are over-valued or price trends are falling, and increasing your equity exposure when market risk is low, can help you to maintain a more consistent overall risk exposure. 

At first glance, the often-used “unaware” fixed asset allocation seems to provide a constant risk profile. In reality, however, underlying market risk is passed through, so your overall risk level is constantly and invisibly changing with market conditions. Adjusting your portfolio to counterbalance changing market risk can produce improved risk-adjusted returns, which is the best measurement of effective portfolio management. Additionally, awareness of leading asset classes provides the capacity to emphasize investments that are performing well in the current environment.

MarketAware^SM  does not attempt to increase gains, because MPT says that gains can only be increased by taking more risk (i.e. buying with borrowed funds or otherwise adding leverage to the portfolio). You cannot have a long-term diversified return that is greater than the underlying asset class. Temporary outsized gains, produced by non-diversification, that are followed by outsized losses are of no value. 

MarketAware^SM  focuses on managing risk. Using a client’s risk tolerance as a starting point, the MarketAware^SM  approach increases risk exposure (and therefore the potential for gains) in a low risk environment and reduces it in a high-risk environment. This, coupled with selecting appropriate asset classes, leads to the overall goal of producing higher risk-adjusted returns, which is the objective of serious investment management.

The Origin of  the MarketAware^SM Approach

David Linnard, President of LFM&P and portfolio manager, developed the MarketAware^SM approach for his own benefit and personal use. Because he never wanted to take more than necessary risk, the ubiquitous passive fixed allocation strategy was never a comfortable prospect. He recognized the necessity of investing to provide for his long-term well-being, but never accepted the idea that  sustaining bear market-sized losses was necessary. It was also disturbing that in many cases, retirees and others who are living off investment returns could be hurt by having to withdraw funds when the value of the portfolio has been beaten down during a bear market. This creates a situation that is just the opposite of the well-known dollar-cost averaging strategy, since more shares are sold at lower prices, lowering the average sale price per share.

Thinking that there must be a better way for him to manage his own investments, LFM&P’'s MarketAware^SM approach was developed over the course of many years. The MarketAware^SM approach does not accept the premise that active strategies are impossible, and so far the actual results agree*. The reason is because human emotion exists, and that at any given time markets may be undervalued because the participants are pessimistic and risk-averse, or over-valued because participants are “irrationally exuberant”. In addition, market prices tend to move from one extreme to the other. The very existence of such movement attracts others to hop on the bandwagon in a phenomenon called “momentum”, which if recognized can also produce greater gains than the fixed allocation approach.

  *We will be happy to e-mail a copy of the historical results if you request at results@linnardfinancial.com The seven-year results do not necessarily imply that future results will be similar. Future market conditions will be different and returns are unpredictable. It is possible to lose money even with a risk management focus.