fundinvestguru  - Insights into avoiding knowable and unknowable ris   |2011-03-20 09:24:33 Words of wisdom: Some possible strategies and insights to address these acknowledged risks: • “Risk is central: Do not think you can know the unknowable or predict the unpredictable?” I think many of us will agree that the most troubling risks this decade can be attributed to the fact that due to the interrelationship of economic trends “the only thing that goes up in a down market is correlation” as reported in a Rydex White Paper. • “Knowable” risks might include; 1. When interest rates on newly issued similar bonds rise, bond fund values decline (the longer duration, the greater the risk; the lower the default risk, the higher the value risks), 2. Large-cap dividend-paying stocks can react like “stocks masquerading as bonds” and 3. A declining US dollar and a rising commodity-driven economy with a seller’s market in infrastructure materials combined with a strong local currency has great potential for lowered-risk and more-reliable profits. • The growth of available sector funds from the 70 style-boxes offered by traditional funds to the more than 700 style-boxes offered by ETFs may facilitate prudent diversification of to reduce risks that are “Unknowable.” 2. “Risk is not uniform: Market conditions continually vary and risk takes many forms--be prepared.” Does this make you question the wisdom of buy-and-hold investments in passive portfolios? Does it make you think twice about the value of an experienced third-party investment advisor who has a successful track record of adapting portfolios to market conditions? 3. ‘Risk has no blanket cure: Techniques need to be optimized for different market scenarios and types of risk.” Avoid “knowable” risks and diversify to reduce “unknowable risks” or hire an experienced (10-20 years experience) portfolio manager who will. 4. “Risk-adjusted returns matter: You should not take uncompensated risk, but must be appropriately rewarded for the level of risk taken.” Allow me to suggest a few examples of properly-compensated risk: 1. High-yield or junk bonds pay higher returns to compensate for additional credit risk and junk bond funds both screen individual bond crises and diversify among individual bond holdings to both diversify and reduce those risks. 2. In the current financial crisis without the former insurance safety nets Muni-bonds, muni-bond funds may face both rising interest rate and credit risks much greater than any tax preferences. 3. The huge losses in 401(k) Company stock investments in large-cap stocks and broad indices in this 21st century during the 50% down markets in 2000-2002 and 2007-2009 that did the greatest harm to retirement savers. The ill-timed introduction of ill-considered target maturity funds and over-cautious and interfering employee savings plans added insult to injury. Half of all direct savings contributions ever made to tax-deferred savings plans has been lost to poor investments. 5. “Risk is not static: Constant monitoring and reevaluation are required.” However, that vigilance is not warranted if the advisor does not have a plan to adapt the portfolio to reflect a revised strategy. That’s understandable as few, if any, fund families pay 12b1 fees or charge loads on balances defensively shifted to cash and/or provide access to bear market funds. The latter can be like “grabbing a falling knife.” The final insight I would like to provide is that there are enough high-return low-risk funds and separate accounts from which to choose wisely. Such funds provide some strategic shelter from both knowable and unknowable risks. Yes, it is time to rethink risk to help your clients another “lost decade.”