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Dealing with unknowns
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Investment management insights from a leading Canadian expert.

By Tyler Mordy  | Monday, April 17, 2017


Populism is on the increase around the world – according to one study, back to the levels of the 1930s. That catapults many unknowns into the decision-making process. How can this uncertainty be mitigated? What follows is our response.

Investors, savers…whether of Main Street or financial profession…are perplexed as ever. Major changes have swept the globe in recent years. The primary alerts to these various epochal shifts have, of course, been financial crises, mass behavioral swings, and a pronounced shift to populism (as well as other trends) in the political spectrum.

The loudest bellwethers of this new perspective were the pro-Brexit vote in Britain and the election of Donald Trump as President of the United States. There are others, as well. For example, the Syriza Party in Greece, the Podemos Party in Spain, President Rodrigo Duterte in the Philippines, Geert Wilders of the Party for Freedom in the Netherlands, etc. There are more such shifts to come, perhaps even in France.

What is perhaps less visible to most – though likely the real essence of potential impact – is the collective shifts in global geopolitics. These have potentially monumental implications for economies and financial markets. Looking back, during a 60-year period of multilateral and internationalist leanings, the globe was showered with the benefits of increasing goods trade, cooperation and globalization generally.

In recent years, a new shift has been underway. Why? Primarily because the ultracompetitive environment of globalization left a lot of people behind in terms of economic inequality. A backlash from the discontented populace is now underway. Historically such movements have been the impetus for big changes in domestic affairs. Now, viewed globally, the world is swinging back to imperialism and bilateralism – said differently, to pro-sovereignty, nationalism, and the pursuit of domestic interests. Chants of “America First” are not exclusive to the U.S. “Britain First” and similar slogans are heard in other places.

With all these changes, understandably, we are often queried by clients as to what the outlook holds…to what assurances we can offer that their portfolios will fare well over time…and so forth.

With so many unpredictable and fickle events taking place, it would be disingenuous to attribute any tactical portfolio successes to powers of perfect prediction and insight. Global policy uncertainty is at an all-time high.

Given the present cauldron of change, what approach then must one take to steer through this environment of knowns, known unknowns, and unknown unknowns (to borrow phrases from Donald Rumsfeld, former U.S. Secretary of Defense. See quote above)? How do we deal with the unknowns? We lay out our approach.

1. Firstly, one must develop a disciplined and rational thinking process. It must be based on facts and theoretical causality to the extent possible.

2. Next, one must strive to identify the non-normal, the extremes, and the incongruences of financial conditions against the research of facts and past precedents. For example, at this time U.S. equities are the most expensive in their own right in at least 10 years. Also, they are the most expensive relative to all other countries in the world in at least 10 years. In addition, they are most expensive against U.S. bonds in nine years. This is the type of “extreme” situation that must not be ignored.

3. We must vet popular expectations (sentiment). So doing, we try to pick out the facts from the innuendo and the hubris. The moods of financial markets do not always align with real underlying developments. Sometimes these are as Venus versus Mars. For example, U.S equity markets have soared on the belief that U.S. reform efforts – promised lower corporate and personal taxes – will lift economic growth and profits. However, equity markets have risen in value equivalent to more than 30 times the possible savings in corporate taxes. This triggers an alert, since we cannot square away current market expectations with reality.

4. It is vital that human behavioral trends and psychological dispositions also be considered. Why? Because it is only humans that have complex relationships with “money.” Furthermore, the laws of physics demand that not everyone can be rich and that not everyone can hold the same view without impacting financial markets. The majority is never right…at least, not for very long.

5. Next, we think globally and identify the interconnectedness of factors – so as to better understand how these will impact a globally diversified portfolio.

6. It is then helpful to formulate possible scenarios that may play out in the future. We then assign probabilities to the main scenarios. Sometime there are more potential “wildcards” than at other times. However, never can one scenario have a 100% prospect, nor can we account for the full 100% range of possibilities. These are what we know to be unknowns and unknown unknowns. The reality is that a significant range of possibilities will always be unknown to us. This is the big handicap we all face.

7. Finally, and crucially, we must therefore diversify portfolios both in terms of asset type holdings, scenarios, global versus domestic content, asset mix, currencies…etc. Here we meld and/or tilt whatever informational perspectives that we have (and there may be many of these) with risk minimization.

Does all of the above sound daunting or boring? We actually do take all of these steps – discussing the various scenarios and factors around the conference table – at our quarterly tactical strategy sessions which are conducted over eight days (and, that does not include the time we spend on preparations and the regular weekly strategy meetings). Every step is documented, leading to a multifactorial, diversified strategy, which is then applied to all client portfolios.

The most crucial outcome of our disciplined investment process must be “No Big Mistakes.” Everyone is destined to make misjudgments about the future because of the “unknown unknowns.” These are usually not terminal. But “big mistakes” take a long time from which to recover (due to the mathematics of big losses).

Emotionalism and populism, are playing a particularly large role in financial markets at present. A disciplined “thinking regimen” is more needed than ever.

That will contribute to the avoidance of big mistakes. Crucially, a process like we have described bridles the anxiety and emotionalism that arises in times of great uncertainty. It is these emotions that are potentially the most lethal for investor. Short-term decisions driven by these are often regretted.

Independent research shows the crushing impact of emotionally-driven decisions. Most investors do not even earn returns of a short-term bank deposit.

In conclusion, diversification and both disciplined thinking and decision-making are necessary to the task of managing investment portfolios. And a bit of luck will always be welcome, too.

Tyler Mordy, CFA, is President and CIO for Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. He specializes in global investment strategy and ETF trends. This article first appeared in Forstrong’s Gobal Thinking feature. used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at Follow on Twitter at @TylerMordy and @ForstrongGlobal.

Notes and Disclaimers

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

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