2018 has been a remarkably difficult year for market investors worldwide. No major asset class has gained more than 5% year to date, and most are significantly in the negative. I read an article last week by Ned Davis Research, which examined this in detail. The result is that we are experiencing the worst year since Nixon’s presidency for investments across the board. Stocks worldwide are down double digits (with U.S. stocks being the one bright spot, and even they are now down), investment grade corporate bonds are down, long U.S. treasuries are down, commodities are down, real estate is flat, even gold is down. We have seen steeper losses for stocks in the past, but we haven’t seen this kind of overall dismal investment environment in 43 years. Absolutely nothing has worked for investors this year!
At Cabana, we build portfolios that consist of all major asset classes in order to give investors the opportunity to efficiently invest and thus participate in the products of human invention worldwide. By investing in all assets within one portfolio we also can provide our investors with incredible diversity, with the goal of minimizing volatility and containing losses. We believe in this methodology so much that all of our portfolios have a “target drawdown” number identified at the forefront. The portfolio’s number, whether it is 5, 7, 10, 13 or 16, can be easily understood and translated to the amount of drawdown (the maximum amount an investment can be expected to fall from peak to trough during a specific period), in percentage terms. How easy is that? Simply pick the number you are comfortable with and invest accordingly. We believe that if you limit your losses during bad times and stay invested, it is easier to make money when investing conditions improve over time.
Given the information provided above, I thought it timely to revisit our process of tactical reallocation of assets and why it is relevant in even the most difficult of times. First, it is important to understand that investing is a zero-sum game. By that I mean that all money has to go somewhere. If a stock or bond is sold, the investment has only changed its character from a stock or bond investment to a cash investment. If that cash is then used to buy corn, oil or real estate it has once again changed in character, but the underlying capital has not. Of course, I am over simplifying things a bit as supply and demand impact the price of each investment, but the underlying premise is sound. With this in mind, we recognize that the relative attractiveness of each investment option is dependent upon the investor’s perception of the investment opportunity. All investors want to make a return from the deployment of their capital. There is one more caveat to consider. Investors want the return so long as there is not more risk than they are willing to stomach! Even the best possibility of return may not be worth it if it also comes with the prospect of losing everything. We believe that risk and reward as it relates to investment in various assets is inherently tied to the worldwide economic cycle. Much like the four seasons, the economic cycle repeats itself over and over again and can be measured. At certain points within the cycle some assets are perceived to be more valuable than others. Those assets, which are perceived as more valuable by investors at a particular time solve for both return and risk. Return is obtained by virtue of demand for the asset by other investors and risk is minimized by the corollary. Demand for an asset necessarily reduces the risk of owning the asset. At Cabana, our algorithm is actively monitoring general conditions within the economic cycle and identifying those assets that are relatively attractive at any given time. When times and conditions change, we reallocate our capital to those assets which correspond favorably to the new environment. Finally, within each portfolio we build in other asset classes that are inversely or non-correlated with the favored asset classes. We build in other assets that zig when our favored asset classes zag. Through this, we seek to reduce volatility and limit losses when things get bad. The process I just described is what results in our Target Drawdown Series of Portfolios and is how we aim to stay invested throughout good and bad times.
How does this work in tough times? Let’s take 2018 as an example, when investors have taken their capital out of all major asset classes and left it in the cash bucket. For reference, as of Friday, December 7, the U.S. Dollar was up 8.1% this year. While market conditions in 2018 have not allowed us to reallocate into rising assets, tactical allocation has allowed us to limit losses as some asset classes fell out of bed. Even in times like these, all investment performance is relative. I am proud to say that relative to other investments our portfolios have held up well this year. From October 1, 2018 to market close on December 7, 2018 we saw the following:
- S&P: -10.1%
- QQQ (Nasdaq 100): -13.5%
- ACWI: -9.9%
- Cabana Core Tactical Income 5: -3.3%
- Cabana Core Tactical 7: -2.4%
- Cabana Core Tactical 10: -5.2%
- Cabana Core Tactical 13: -7.0%
- Cabana Core Tactical 16: -8.5%
- Cabana Core Tactical 20: -6.9%
The above Cabana returns are presented net of advisory fees.
All of our portfolios have outperformed during a time when we have been invested primarily in stocks. The reason for this can be attributed to our reallocating to more defensive types of stocks in early October as conditions deteriorated. All the while, we have remained fully invested, collecting dividends and prepared to participate in gains if the market recovers. Alternatively, If the economic conditions continue to suffer, we will likely reallocate to those assets that perform relatively well in a weak economy. We don’t catch tops or bottoms of markets and we are not traders. Our primary goal is always keep our client out of trouble whenever possible and to stay invested for the long run.
-G. Chadd Mason, Cabana CEO