Financial advisors must be prepared for change as they guide their clients. Portfolios designed with multiple risk-managed strategies can help—actively adapting to significant changes in market conditions.

As has probably been the case for all of you, change has been a significant part of my life. I was fortunate that when I attended college, times they were “a-changin’.” The computer age was dawning. I was able to see the potential of combining traditional investment analysis with the powerful abilities of the PC. 

A change was necessary. The type of analysis I wanted to do was too computational. It was too intensive to do by hand, and it was not easily repeatable. 

Computers were the solution to my dilemma. They also supplied a discipline in execution that the findings of the yet-to-be-discovered science of financial behaviorism would later show was so difficult for humans to achieve. 

As the years rolled by, change continued. I finished at Michigan State and went off to the University of Michigan Law School. While attending and serving on a congressional staff, I started a hedge fund. I then practiced tax and securities law for 20 years, during which time investments lured me back, and Flexible Plan Investments (FPI) was formed.

FPI is all about change. Our motto, “Managing the non-traditional is our tradition,” says it all. 

We began as a market timer with a single system, thinking we had the holy grail. Today, we manage over 150 strategies and don’t believe any is the sole solution for all market environments. Hence our emphasis on portfolios allocated among multiple methodologies.

Cars, telephones, television networks, breakfast cereals, or beverages—whatever industry you can name, they all change. Coke begets Tab, which turns into Diet Coke, and then New Coke appears, and now we have Coke Zero. We change—telephone, phone booth, long-distance, cell phone, smartphone. We evolve—abacus, slide rule, calculator, room-size computer, personal computer, spreadsheet, artificial intelligence. It doesn’t matter the industry—it’s change or die.

The 60% stock/40% bond portfolio and diversified modern theory portfolios have each flourished. But investment modes changed when the sky darkened and markets crashed in 1963, 1966, 1973, 1987, 2000, 2008, and 2020. New solutions emerged. Factor investing, smart beta, alternatives, liquid alternatives, and—yes—market timing all had their time in the sun. Yet the only enduring constant appears to be “change.”

Markets appear to be on the cusp of a significant change

Why am I writing about “change” now … in early 2022?

I could have addressed that question with a simple, generic answer when I started to work on this article: “It’s a new year, a time for New Year’s resolutions that seek change.”

But it is more than that. The ingredients for a change in the markets’ menu are there. Everything that matters seems to be reversing its previously bullish direction:

• Inflation has been practically nonexistent for more than a decade. Now we’re seeing 40-year records routinely broken with each monthly report of a rise in the consumer price index and producer price index.

• Interest rates are rising. We’ve been in a bond bull market for more than 30 years as interest rates moved lower. But the Federal Reserve is signaling that it’s going to change the rules of the game this spring. Three to five interest rate hikes are forecast this year by various market seers.

• In the same vein, liquidity is going to take a hit as the Fed intends to stop buying bonds (in fact, it may start selling them), and the Biden administration appears to be abandoning its plans for trillions of dollars of new spending.

• Corporate earnings, which have been soaring in large part because of the present favorable environment, are slowing—and with them market price momentum in the equity markets.

• All of these actions started to happen when valuations were high for stocks and bonds. Of course, valuations can always go higher (although, the S&P 500 began the year with a price-to-earnings ratio in the 88th percentile of readings since 2010).

It’s time to prepare for change

As an active manager and a contrarian, I know those in the market already focus on these concerns. And I know that the market usually acts to fool most people most of the time. Experience has taught me that it is all in the timing. The overvalued markets can fly high for a long time, and bull markets last longer and are more frequent than bears. 

The present market slide could be a pause in a longer-term move higher. We may see a mere 10% correction, or the bull market could resume.

But it is critical to be prepared for change with conditions like these. Being prepared is the number one piece of advice for those who need to adjust to change. The second piece of advice is that avoidance does not work.

One needs to take proactive steps to anticipate the effects of change. That means having coping strategies. Yes, these should include strategies that can address changes in the market environment. But it goes beyond the investment process and includes the adoption of coping mechanisms for the new financial landscape. It can require a change in approach and a change in expectations. 

It also generally requires seeking professional help. Financial advisors can help their clients tremendously from a behavioral perspective. And professional investment management can aid both you and your clients.

Testing the waters and adjusting expectations

Analysts in discussing change tend to talk about abrupt and sudden change, like in the pandemic collapse of 2020. But that was hardly a normal correction. After all, it was the fastest bear market ever. More often, bear markets begin with a loss of momentum and demonstrate weakness over time. 

Lakes have recently frozen here in Southeast Michigan. I’ve been looking out my window at the first brave explorers of the newly frozen surface that backs up to my cottage. 

Each moved cautiously at first, slowly testing. As each ventured out onto the ice, you could see them listening for that crackling sound that might indicate insufficient support. You knew they were watching for visible signs of a fissure that could spread or widen and send them into the frozen waters beneath the ice. It was a slow process for travelers, requiring patient testing before confidently moving off in the direction that each wanted to go. 

In the same way, most market changes occur over considerable time. And, like those explorers first stepping upon a newly frozen lake, it can take time to recognize that a change is happening and longer still to determine if it is significant. 

That is why nobody can precisely call market tops. And it is also why even market professionals take losses at the top as they wait for a new trend downward to establish itself. Acting too quickly does not respect the lasting power of a bull market. It can expose investors to the debilitating losses of whipsaw trading.

It also means investors have to adjust their expectations when market seasons are changing. Trending periods are the best of times. We have enjoyed the benefits of being invested over the last two years, when the trend has been primarily up. 

With the market exploring a change in trend, investors need to expect to have to wait patiently during a reasonable testing time. It is a time when each strategy assesses whether the market is simply in a pause or, instead, heading on a course that will take it much lower. 

Each strategy uses its own time-tested approach culled from market history to determine the best course of action. The various methodologies will not all act at the same time. Some will ease into defensive positions, while others will stay the course. Some will be right and others wrong.

See Related Article: Why clients should follow their investment playbook

Building an adaptable portfolio with multiple strategies

For that reason, we have found that a portfolio built on multiple strategies has had the best chance of getting market turns right for at least a portion of the assets under management.

Our Research department just completed a thought experiment. With rising inflation dominating the headlines, they used our Crash Test Analyzer tool to see which of our strategies performed best in such periods. 

The results were telling. Seven of the 10 best-performing strategies were turnkey multi-strategy portfolios. 

These results suggest that a portfolio of single-strategy offerings is probably not the best solution for your clients, whether you use the services of our firm or those of another investment manager. Rather than leaving you with the task of hunting for the next winning strategy from the many available or trying to find the one with the best chance of dealing with a new market environment, a multi-strategy portfolio can make all the strategy selection decisions, allocations, and positioning for you and your clients.

An investor wish list for dealing with change

If change is constant, why not have an investment strategy built to deal with the fact that markets are constantly changing? 

Why not have different strategies for different market environments? Why not have systems that adapt to changing financial landscapes? Why not have portfolios made up of multiple, dynamic, risk-managed approaches too? And, while you’re at it, why not have your portfolios reallocate automatically among the available strategies, adapting the portfolio to what is working in the markets at any given time? 

After over 50 years of personal study and 40 years of FPI development, we have our answer to these questions. Our turnkey strategies can provide that answer. 

These low-cost strategies provide three levels of risk management:

1. Dynamic risk management within the 12 Quantified Funds that we subadvise. 

2. Actively managed strategies that exclusively utilize investment between these funds.

3. Computer-directed, dynamic allocation among those strategies to create true multi-strategy, suitability-based portfolios.

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Some people seek out change. Other people fear it. Some people work for change. Others avoid it.

Just as risk is always with us, change is always a constant. Be prepared.

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.