Is Your Role Risk Manager or Soothsayer?
On any given day, I read plausible arguments in the financial press about either the impending collapse of the U.S. dollar or the inevitable ascendancy of the U.S. dollar above every other currency. I could spend months doing my own research on the merits of either opinion and create seemingly airtight arguments for both sides. But what would be the point? So, which side do I believe? Neither. What should I do with the information? Hedge both outcomes.
The fact remains that any intelligent person can construct volumes of reasonable arguments defending virtually any point of view. This just underscores an unalterable fact of life and investing: Nobody knows the future.
An advisor who truly accepts this fact will tend to change his or her investment approach from a conjecture or opportunity perspective to one of thoroughly assessing known risks and taking a methodical approach to managing them.
Currency markets—like any other market—trade based on the opinions and views of millions of people. Allocating to and managing risk across all asset classes is central to any risk mitigation strategy. In the end, the performance outcome of a portfolio will be measured in terms of how well it was allocated across all asset classes.
Interestingly, the primary cause of one portfolio outperforming another will probably not result from being under or over-weighted to any one asset class. It will likely be based on whether an asset class is excluded for a meaningful period of time. Once you see the logic behind this argument, your focus changes from looking for “ideal” investments to identifying every conceivable risk—and then hedging it by proportionate investment within a non-correlated asset class.
I can think of many reasons why most investors don’t pay attention to custody risk, counterparty risk, reference currency risk, liquidity risk, illiquidity risk, leverage risk, arbitrage risk and private market risks. It may be time to start educating your clients about all these risks and others—and find out how each is tied to a compensating opportunity.
All risks are paired with compensating opportunities. The secret to success, then, is realizing that risk and opportunity are two sides of the same coin. The more we discover new risk categories to invest in, the more we discover return potential that may help us achieve our goals.
Will the dollar rise and fall over the course of my lifetime? Yes.
Am I allocated in such a way that a meaningful part of my net worth works well in either case? Definitely!