On the road, foul weather creates hazards and panics drivers. In markets, drawdowns have a similar impact.
For smooth investment journeys, mitigating the risk of capital loss is essential.
Foul weather, hazards and poor road surfaces are inevitable on long journeys. And when storms flood roads and scatter debris, other motorists can panic.
To go the distance, managing risk is essential. Indeed, avoiding or minimising exposure to market drawdowns not only improves risk-adjusted returns, it can also be more important than picking winners in the long run. For instance, if you invested USD 1 in the US stock market in 1988, by today you would have accumulated $32. If you missed the best 10 days, this payoff would fall to USD 15. But it would grow to USD 35 if you also avoid the worst 10 days as well. This reinforces the importance of managing downside risk.
Are you aiming to minimise the impact of market drawdowns while remaining as diversified as possible? At Lombard Odier Investment Managers, we actively manage the total exposure of our multi asset portfolio and may, at times, allocate meaningfully to the only certain safe haven: cash. By dynamically sizing a portfolio in this way, we aim to preserve capital, stay true to the prescribed risk target, maintain diversification and reduce volatility.
This dynamic drawdown management methodology, which we have applied since inception and subsequently enhanced, is core to our way of risk-based investing.
It also helps us limit downside, but also stay true to performance targets by increasing our market exposure. For instance, if market conditions were supportive and the risk level too low given an investor's return objective, the portfolio's size could be increased (potentially through leverage) to reach the goal. Conversely, if risk is rising or too high, scaling down this portfolio and adding exposure to cash makes it possible to stay on target while maintaining diversification.
This post is funded by Lombard Odier Investment
