Investment Committee & IA Report – March 2015

Despite having three full calendar years without a 10% correction in the S&P 500, volatility appears to be on the rise. Krilogy has the systems and team in place to actively manage this volatility for clients and keep portfolios allocated to their appropriate risk tolerance.

Portfolio Stress-Testing
All Krilogy Portfolio Models undergo forward-looking stress testing as part of our ongoing due diligence. Many risk scenarios have made headlines recently and our stress testing process provides Krilogy’s Investment Committee and your Krilogy advisor with analytical tools not available to most investors. The portfolio models have been stress tested against a number of scenarios over the past quarter, including:

  • What if deflation takes hold in developed economies worldwide, resulting in lower economic growth and poor market performance? The collapse in oil prices shows deflation in commodities, which may spread to all markets. If deflation overtakes most of Europe, a global recession might not be far behind.
  • What if the commodities drop and steadily falling CPI in 2013 are a prelude to a market correction? Equities markets generally underperform in deflationary periods, and if commodities and CPI are indeed predicting falling prices, the stock market and economic growth both might not be far behind.
  • What if the slowdown in Europe turns into a full-blown return to recession? Bailed-out periphery nations remain weak and could require more assistance, US equity markets would correct as international growth prospects dim, bonds would rally as 10y rates fall further below 2%, and commodities would fall further, with a downward spiral occurring in the price of oil.

Market Comments
In our efforts to combine the benefits of active and passive investment management, we’ve spent a great deal of time analyzing the macro-economic environment, while doing our customary due diligence on investment positions within and outside of our portfolios. With the current market cycle over 65 months old, a tad beyond the average cycle in post WWII era, it takes more than just age to cause a cycle to change course. Furthermore, while there are imbalances on our radar, overall conditions still suggest a compelling case for equities, but perhaps with broader diversification than what has worked over the last several years. Specifically, the U.S. market has produced solid returns in 2013 and 2014, especially, but QE has ended and fiscal and monetary policy tailwinds exist in other regions throughout the world, such as in Europe and Japan. Additionally, we have a strengthening US dollar, which can hurt US exports and bolster foreign competition.

On the flip side, we have a decline in oil in the energy space, which could result in job loss, but potentially result in benefits for US consumers and businesses. After QE ended in October, we’re looking for a Fed rate hike to take place toward the middle to latter part of the year. As is always the case though, the data will dictate the beginning of the move and nothing is a given, as we’re reminded by most strategists’ incorrect calls in their expectation of the direction of interest rates in 2014. This reality serves as a great reminder of how important it is to keep emotion aside and stay true to a disciplined, diversified approach to asset allocation. The volatility that has become increasingly present, within both the equity and fixed income markets, have allowed us to implement our disciplined process for trimming gains and adding to attractively valued positions through our Dynamic Rebalancing Process.

Dynamic Rebalancing
In moments where day-to-day or week-to-week headlines create opportunity, our Dynamic Rebalancing process allows us to maintain discipline in trimming gains and adding to positions that are oversold. Krilogy’s Dynamic Rebalancing process provides a personalized, account-specific, and security specific system that creates discipline in keeping you within your target risk tolerance range. Our customized system allows for asset class appreciation, while creating discipline around selling high and buying low. While asset management is as much of an art as it is a science, we let statistical analysis help drive our unique process in an effort to take emotion out of the equation, which ultimately has the ability to negatively impact many investors. For Krilogy clients, each account is monitored on a daily basis for any deviation in the volatility tolerance band and rebalanced as needed to mitigate excess risk. In recent weeks and months, we’ve had opportunities to trim long-term Treasury-Bond exposure and real estate while adding to international exposure, high yield bonds, and some energy exposure amidst the market volatility.