Investment Committee & IA Report – November 2014

The markets continue to be very active, with many recent ups and downs. Krilogy is actively managing this volatility for clients:

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:

  • How will markets react to the end of the Federal Reserve’s quantitative easing (QE) program that ended in October? The portfolio models were stress tested in scenarios such as Fed policy changing too soon resulting in significant losses in risk assets, the Fed using low short-term interest rates to maintain relatively flat markets without QE, or the Fed implementing policies that drive the markets even higher after QE ends.
  • How will markets react to geopolitical tensions around the world? The portfolio models were stress tested in scenarios covering a wide range of possible outcomes in the Middle East, including US involvement against the fight against ISIS. Stress testing was also performed on the conflict in Ukraine and the resulting sanctions against Russia as well as stress tests for both global deflation and global inflation scenarios.

Qualitative Due diligence:
Six risks deemed most common to consider when selecting investments are: market risk, liquidity risk, credit risk, interest rate risk, country risk, and currency risk. Two often forgotten (but just as important) types of risk to consider when investing are management risk and headline risk.

Headline risk refers to the possibility that a news story will adversely affect investor sentiment and ultimately an investment’s price. Management risk is defined as the risk associated with ineffective, detrimental or an underperforming management team, which can impact shareholders and the company/fund being managed. It can also include departure of key member(s) from the management team. This uncertainty or negative public exposure from such an occurrence, can ultimately lead to selling pressure in relation to an individual equity or redemption and selling out of a fund, in the case of a mutual fund.

On December 5th of last year both of these risks began to arise in one of our main portfolio holdings (PIMCO Unconstrained Bond). On the 9th of the same month, our Investment Committee held a due diligence conference call with the fund company. Afterwards, the fund was placed on heightened supervision. These risks did not dissipate and instead, in March of this year, became more prevalent. On March 24th the Committee unanimously voted to remove it from our portfolio models. Within seven hours of the Committee vote, the holding had been removed from our portfolios and 78% of the firm’s holdings in the position had been sold. By September 26th, when both risks were finally realized, over 99% of the firm’s holdings in the position had been liquidated. Market

Comments/Dynamic Rebalancing:
So far this year, we’ve witnessed a notable pickup in volatility within both the equity markets and fixed income markets. In fact, consensus opinions about the direction in price movement of treasuries has been quite wrong, thus far. For instance, with the 10 Year Treasury Bond starting the year at a 3% yield, many strategists had the year-end target yield in excess of 3.5%, when in fact it dipped as low as 1.8% in recent weeks and currently hovers around the 2.3% range. Much of the market volatility that has transpired this year can be attributable to the following list of concerns, including Ebola, ISIS, economic data, corporate earnings strength, the ending of QE, global slowdown, and Ukraine-Russia turmoil. In moments where some of the day to day or week to week headlines create opportunities, 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, we’ve had opportunities to trim Treasury-Bond exposure, while adding to large cap growth and international exposure amidst the market volatility.

The Krilogy team and technology are at work for you each day, focused on your needs, goals, and your accomplishment.