Unfiltered: Answering our client questions

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"With all the bad news, should I reduce my risk level?"

Client Question - Anonymous

Hi Rosecut Team,

I've been seeing more and more on the news about global recession, interest rate rises, inflation, stocks plummeting, and many legendary investors all saying the same thing, that we're in a super bubble and it's ready to pop with losses in the market that are the worst it's ever seen.

I'm concerned about the risk tolerance of my accounts, caught in between decisions of either (i) reducing at this time to the lowest risk possible OR (ii) with what the cost of living and energy crisis entail, to even cash in my ISA and to sit it in my savings account ready to reinvest when markets and the global economy look to start stabilizing and improving.

Losing 50% of my current investments doesn't make sense to me, but cashing in and reinvesting when stocks and ETFs are down in value at it's bottom makes more sense in the long term.

Please let me know your thoughts on this action.

Rosecut Response - Daniel Greenhough, Portfolio Manager
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This is a question that many people will ponder at some point in their investing life. The short answer is no, I don’t think you should. Let me try and explain why.

Markets go in cycles. In a manner that is linked to the business cycle, the market cycle has periods where different asset classes outperform. A business cycle has a recession or trough phase, an expansion phase, a peaking process and then contraction before repeating. However, it is difficult to forecast exactly where we are at any one point, and no two cycles are the same, hence we hold a mix of assets and adjust the proportion in each asset based on the probability of where we are in the cycle.

Now, inevitably there are times when the news flow and commentary pick up on the negative performance of equities – after all, they don’t go up in a straight line. At this point, the temptation to try and time the equity market by going 100% to cash and waiting until things sound better, raises its head.

The problem is that by holding cash outside the portfolio all the emphasis is put on you, the client, accurately predicting with 100% certainty that the time is right to re-enter. Our view is very clear, the cash should be left inside the portfolio. The difficulty of trying to time the market for professional investors, never mind those who don’t have the time to devote to markets, cannot be under-stated. As a reminder, markets are forward looking, the part-time investor would have to be confident of predicting what people will be focusing on, in 12 – 18 months’ time. Reading the news of the day, and investing off the back of it, unfortunately means one is always too late.

Changing your risk level is a variation of the above approach. You are essentially trying to time the market. This is not a great reason to change risk level unless you are confident of timing the market.

A valid reason for changing risk levels, would instead be a change in your personal circumstances. For example, a life event that reduces your capacity for taking risk.

So, why leave it to us?

As mentioned earlier, at different points in the cycle, different assets outperform. This year, inflation type assets have outperformed, e.g. the energy sector ETF. If the next stage of this cycle is economic growth turning negative and bringing inflation down with it, then we would expect the outperformance baton to pass to government bonds. This is not a one-day event, but a transition period which only looks obvious with hindsight.

The decision making over which assets we overweight or underweight is where we add value by hopefully achieving better returns when markets are going up, and not falling as much when markets are falling.

So far in 2022, we have done a decent job of this.

The below chart shows how the Rosecut Growth model portfolio (in the purple colour, labelled ‘GBP Growth’) is performing against the industry benchmark.

One decision we made this year, was to hold much more cash than usual, at the expense of equities. We would generally hold 70% in equities in a growth portfolio over the long term. At present, we only hold 55%. In addition, cash is 25%.

This is protecting on the downside and gives us a lot of cash to add to equities when we see an opportune moment. One thing we have not seen so far this year is a capitulation moment, when the market implied measures of volatility spike, and correlations go to 1 (meaning everything goes down at the same time) as other investors are forced sellers. At this moment, investors with cash on the side-lines (like Rosecut) have the opportunity to step in and buy assets at cheap prices from panicked sellers.

To end, I would reiterate my belief that the best approach is to stick to the growth portfolio that best fit your attitude and capacity for taking risk. Within the growth portfolio, we have already taken steps to reduce the risk, and constantly monitor the markets looking for the buying opportunity.

Please note that this is not a financial advice and it does not take into account individual circumstances. Please also contact a professional advisor prior to any decision making.

The value of an investment and the income from it can go down as well as up and investors may not get back the amount invested. This may be partly the result of exchange rate fluctuations in investments which have an exposure to foreign currencies. You should be aware that past performance is no guarantee of future performance.

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