Milestones, Managing Risk & More

Tim and Jake discuss the firm reaching a $1 billion dollars in assets under advisement, as well as more on the backstory and status of the firm’s exciting new partnership.

FIVE THINGS YOU SHOULD KNOW

Equity Markets – were mixed this week with U.S. stocks (S&P 500) down -0.79% while international stocks (EAFE) gained 0.35%
Fixed Income Markets – were lower this week with investment grade bonds (AGG) down -0.06% while high yield bonds (JNK) fell -0.48%
Fed Hike – As expected, the Federal Reserve announced a 0.25% increase to the benchmark lending rate, while also suggesting this may be the last hike. Fed Chair Jerome Powell’s comments fought back at the notion that a recession is imminent stating “the case of avoiding a recession is in my view more likely than that of having a recession.”
JPMorgan Buys Out First Republic – Over the weekend US regulators held an emergency auction of First Republic Bank, with JPMorgan winning out and assuming all deposits held by the bank. In total JPMorgan assumed $173 billion of loans, $30 billion of securities, and $92 billion in deposits, making the nation’s largest bank even larger. Per the deal JP and the FDIC will share the burden of losses, as well as recoveries, on the firm’s single-family and commercial loans.
Key Insight – [VIDEO] Tim and Jake discuss the firm reaching a $1 billion dollars in assets under advisement, as well as more on the backstory and status of the firm’s exciting new partnership. [ARTICLE] Ben breaks down the difference between volatility and risk, an important differentiator we like to discuss with clients to help them on their financial journey.

INSIGHTS for INVESTORS

“The dangers of life are infinite, and among them is safety.” — Goethe

Risk vs. Volatility – The important roles of time and diversification

by Ben Klündt

Most have heard something along the lines of “the greater the risk the greater the prospect of reward.” This line of logic has its truths as it relates to investing. Today I want to dig into the idea of risk but do so while addressing how it differs from volatility and is impacted by diversification and one’s time horizon.

Let’s get some general definitions out there. I would define risk as a permanent impairment of capital (you lose money with no prospect of getting it back.) When it comes to volatility, I like to think of it, and define it, as a temporary impairment of capital (your value may have decreased but it is not permanent and has the prospect of a rebound). I’m going to attempt to talk through the two differences and illustrate them in the form of charts below.

When it comes to risk one needs to consider both, their time horizon for the capital invested and the prospective return they may receive. If you have a definitive time frame in mind after which you’ll need the capital back, most should really focus on their personal risk tolerance and likely reduce the potential “volatility” that could be turned into risk due to a shortened timeframe. This of course means also adjustment downward one’s expectations for potential return.

The chart below illustrates what can happen when we refer to a permanent and “total loss” of capital. The investment goes to zero. When someone says something to me like “you can’t make money in the market” it tends to be because at some point in their life they experienced this type of “risk.” Of course, these types of “total loss” situations are almost always tied to someone having an overly concentrated position. For example, those that had their money invested in the now infamous company called “Enron”, only to find out in time the company was built upon fraud and utterly worthless.

The next example of risk would be a permanent loss of capital, but not a total loss like above. Think of this as a stock that just never reaches its prior level (e.g. many banks stocks after 2008, or various tech stocks from 1999). You likely experienced some good periods of return but some catalyst caused you to have to sell thus ending your hold period, along with your chances to recover any losses. You get out what you can, and the investment position is closed. That’s illustrated by the chart below.

Volatility is a very different thing, it’s a temporary setback. An oft-used industry saying is that “volatility is the price you pay for making money as an investor over time.” Think of it as a “temporary fluctuation” that trues itself up over time within a longer-term upward trend. In the midst of tough times, volatility can absolutely feel like risk, but with patience and time it works itself out. Furthermore, while a well-diversified portfolio isn’t immune from volatility it makes the odds of true risk for your overall portfolio virtually non-existent. Again, the timeframe of the impairment is the key difference between volatility (short-term) and risk (permanent).

The chart below illustrates volatility both in terms of peak to trough or trough to peak.

It’s prudent to remember that volatility is the short-term price ones pays for a long-term return. Temporary losses generally correct themselves when given enough time to do so.

One way we at Ten Capital help reduce the “pain” of volatility is through owning a well-diversified line up of investments across varying asset classes that don’t react the same to the same economic or market conditions. While one asset class may not be performing as well during a particular period in the market cycle, it is quite likely that another position will be. As the joke goes in the industry, you know you have a well-diversified portfolio when there’s always a part of it you are less satisfied with.

To recap, reducing one’s true risk from permanent loss is about:

Knowing your time horizon (which can help be defined through a solid financial plan),
Diversifying one’s positions and asset classes properly to reduce permanent losses either from positions going to zero, or from having to sell positions that are down during volatility do to unexpected life events
Both remembering that volatility and risk are different, and quite possibly having a partner that can help you do so during those periods of market volatility

Helping clients employ, and stick to, the tactics above is a big part of the value we hope to bring to our clients here at TEN Capital.

Never hesitate to reach out in a period of volatility whether it’s for a reassuring word or to confirm your plan, we are always here to help. Ultimately, success comes to those that stick to the path and process that was determined during a period of calm and corresponding sanity.

Have a wonderful weekend,

Ben and the team at Ten Capital

DATA, JUST THE DATA

Data points this week included:

U.S. Jobless Claims – the number of initial claims last week rose by 13,000, higher than expected. Continuing claims on the other hand fell 38,000 for a total of 1.805 million.
Eurozone Retail Sales – fell -1.2% in March for the second straight month of contraction. The largest decline came from Germany (-2.4%) while Spain saw the strongest improvement (+0.7%)
U.S. ISM Manufacturing Index – rose to 47.1 in April following March’s 3-year low of 46.3. This now marks the 6^th consecutive month that economic activity in the manufacturing sector shrank.
Eurozone Unemployment – fell slightly to 6.5% in March for the lowest rate on record. A tight labor market coupled with high inflation should allow the European Central Bank more leeway for policy tightening.
U.S. Employment – the U.S. economy saw an unexpected addition of 253,000 jobs in April, while the March reading saw a sharp downward revision to 165,000 (from 236,000). The health care (+40k) and professional and business services (+43k) led the growth.