It’s no secret that February was a bad month for the stock market. The S&P 500 fell 12% during the last week of the month and entered March down nearly 8% for the year. It’s very hard to hide when the market trades the way it did. If you have stock market exposure, chances are your portfolio went down in value last month. But diversification plays a large role in just how much your account may have dropped.
Real accounts, Real numbers
Below, we highlight recent performance in three different accounts we manage. These are real accounts with three different risk profiles: Client A is aggressive, Client B is balanced, and Client C is conservative. Every account was at least 99% invested heading into February based on their objectives. So the performance numbers give us great insight into how well our portfolios did matching their objectives. (I.E. we didn’t outperform the market by being in cash at a lucky time).
Each account performed about as we would have expected, with the benefits of diversification helping during a rough stretch for markets. Here are a few of the nuances of each account that helps explain the performance.
Aggressive in equities and bonds
Client A has an aggressive risk profile. So you may have expected the account to be down more than the S&P 500. However, we paired high beta equity exposure with high beta bond exposure inside a 90% equity, 10% bond allocation (90/10). This meant allocations to SPTL (a TLT competitor) and LQD. This exposure came in handy as SPTL and LQD rallied 6.50% and 1.15%, respectively, during the month of February. On the equity side, large-cap growth is our largest holding. And that market segment, ironically, held up much better than the S&P 500 (-6.57% vs -7.92%). Of course, a 7.60% loss is still a nice punch to the stomach. But we still managed to absorb less risk than the broader market, even in a high-risk portfolio.
Client B has a balanced risk profile with 67% of their money in equities, 26% in bonds, and 6% in real estate. Three factors within our allocations really helped the portfolio hold up better than the broader market. First, 12.5% of the equity exposure is in buffered ETFs, with the largest weight being KJAN. These ETFs declined far less than the largest equity holding in this account, SCHV (large-cap value). Secondly, 35% of the fixed income allocation is in bond funds like AGG, SCHR, SPTL, and IGLB. All of which rose between 1.50-6.25% in February. And lastly, about 25% of the fixed income allocation is in short-term cash-like ETFs, such as VGSH, NEAR and SPSB. These were basically flat in February, helping to smooth out overall portfolio volatility.
Conservative for the win?
Client C has a conservative risk profile and their account has an extremely heavy allocation to fixed income. For this particular client, being conservative means preservation of capital and generating monthly income. This is important because, in general, you may think a conservative client owns ETFs like SPTL. And thus, had an excellent month and is having a great year. However, SPTL is actually the smallest allocation in this account, at just 1%. Why? Because long-maturity bonds like SPTL have a lot of duration risk.
So when building a very low-risk bond portfolio, we tend to focus more on short-term duration. Then, to supplement income, we pair low duration with higher-yielding allocations like junk bonds, preferred stock, and investment-grade debt. LQD, for instance, which is a top 5 holding in this account, yields about 3% and has a duration of 9. BSCM, another large holding, yields 2% and has a duration of just 2.3. Compare these to SPTL, which yields just 1.80% and has a duration of 18. So in a portfolio where income and low risk are the goals, SPTL (or TLT) doesn’t make as much sense as you might think.
Expanding on the portfolio holdings, other top 5 holdings include SCHZ (an AGG competitor), preferred stock ETFs like PFXF, cash-replacement ETFs like ICSH, and high-yield bond ETFs like SHYG and USHY. All of these combined for a very low volatility mix in our portfolio as losses in PFXF and SHYG have been offset by gains in SCHZ and LQD. Meanwhile, an ETF like ICSH is helping protect capital and keep portfolio volatility low.
Every account we manage is custom built to meet the specific needs of each individual client. We don’t have a single model for high-risk clients or a reusable template for low-risk clients. One client’s version of aggressive might be another client’s version of a balanced approach. One simple piece of advice for managing risk is to understand how portions of your portfolio are expected to interact with each other. For example, high yield bonds and preferred stocks have an above-average correlation to equities. In other words, they are not great diversifiers to equity exposure.
Periods of volatility like this recent one give us an opportunity to evaluate portfolios and ensure that they are performing how we want them to. Of course, it is frustrating when markets fall as quickly as they did. But if your portfolio fell more than you thought it should have, it may not be that you misjudged your risk tolerance. It could be that what you own doesn’t actually help you accomplish the goals you think it does. Feel free to contact us if you would like us to review your portfolio through a free consultation.
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