Systematic Relative Strength

We’re at a strange place in the market cycle. Depending on the day, investors are either fearful of a further decline or fearful of missing the recovery. No one can tell if we are in the eye of the storm and about to head into the dreaded double dip or if the nascent economic recovery has legs and is about to surprise on the upside. Despite the best year of the decade in 2009, it’s safe to say that investor confidence is still very fragile.

Amid that backdrop, investors have responded by clinging to cash. According to a recent article in Investment News, more than $9 trillion is on the sidelines. Investors need to figure out some way to get back in the game.

Of course, investor angst is understandable. Most investors diversified and tried to be patient, the very behavior they had been counseled to follow. Then 2008 came along and they got whacked when almost every asset class dropped. In other words, they did what they were told and it turned out disastrously for them. Now investors don’t know what to do or who to believe.

It’s not that investors are living in a cave. They can see the current environment and they understand that there are multiple risks they need coverage against: inflation, deflation, currency depreciation, and so on. With the yield on cash at essentially zero, they also know they can’t sit in money market funds forever and reach their investment goals.

Investors recognize that a potentially broader approach to asset classes would be helpful, but they are paralyzed with fear and have no idea how to implement that kind of investment policy. It’s not so much that they are afraid of the market as they are afraid of jumping in (or out) and getting it wrong.

Our Global Macro portfolio offers a possible solution for some of that $9 trillion sitting on the sidelines. Investors, I believe, after being beaten half to death by the proponents of sit-and-take-it investing, are now open to a tactical approach that offers great flexibility of exposure to different asset classes. They can see with their own eyes that the world has changed. They are just confused about how to handle the timing of multiple asset class exposures and reluctant to attempt it on their own.

Their problems can be addressed with something like the Global Macro portfolio because the timing and market exposure is handled for them. If conditions are harsh, the portfolio could be held in fixed income, inverse funds, and cash. If risk is being rewarded, aggressive assets such as domestic equities, emerging markets, and real estate might be held. In an inflationary environment, there might be more exposure to basic materials and commodities. If the dollar depreciates, the portfolio might be heavily laden with international equities and foreign currencies. The other significant benefit is that the systematic relative strength process used to run the accounts continues to adapt to new conditions as markets change. I think investors breathe a little easier when they recognize that there is a specific strategy that is being followed-it won’t be optimal in every environment, but it won’t be driven by fear and greed.

It’s up to each client and each advisor to figure out how to get off the bench and back into the game, but for many clients a global allocation product might smooth the transition back onto the field of play.