The most important thing we do at Tidepool is to actively select the best funds and ETFs for profitable investment lineups. ERISA mandates that investment lineups be designed to minimize the risk of large losses. Our dedicated research efforts keep us abreast of market changes that affect lineup strategies.
The potential for large losses lie in various corners of the financial system. A common theme involves asset correlation — a death-knell to diversification. Our lineup design strategies are driven by the ERISA diversificatIon requirement to minimize the risk of large losses. To that end, we strive to keep plan participants updated on the following important strategy categories:
1. TRADITIONAL STRATEGIES
Traditional portfolio holdings include stocks, bonds, and cash. Virtually all 401(k) plan strategies focus on these traditional investments. The concept of diversification, for traditional plan investors, typically means a mix of large cap, mid-cap and small-cap equities, together with bonds. The typical investment mix is a 60/40 weight of equities/fixed income. We offer lineups that include this traditional mix of equities/fixed income, simply because that is what investors have been taught over many years — and therefore plan participants may want want to stay with those traditional strategies.
But on closer examination, this traditional mix of equities/fixed income hardly qualifies as a diversified portfolio. This is because all equities exhibit strong correlation, which means they rise and fall together, for the most part. So a portfolio of 60% equities will rise with the market and fall with the market. This is not meaningful diversification.
In the rising markets prevailing since 2009, equities have offered a a reasonable strategy, since equity growth has powered the financial markets in this period. But what happens when equities no longer power the market, or what happens when equities or fixed income options suffer a major draw down from lack of liquidity?
Most investors are taught that a 60/40 allocation to equities/fixed income is the best they can hope for. But that simply is not true. Other strategies are available that offer superior performance in volatile markets, as discussed more, below.
By identifying correlation factors between funds and the major market indexes, and by understanding the underlying investing currents and fund flows, our job is to avoid large losses in our investment lineup, while also maintaining consistent profitability.
2. GLOBAL STRATEGIES
Global investment opportunities have moved to the front of many allocation strategies, largely because foreign investments tend to offer de-correlated options. In recent years, global investing trends have moved eastward, particularly to the opportunities presented in China, India and, once again, Japan. By following cross-border investment flows that show long-term trends in particular countries and geographic locations, we are tracking the proverbial smart money, to consider if they have greater opportunities than traditional US funds.
3. RISK PARITY STRATEGIES
Risk parity describes portfolios designed to perform well in any economic environment. A simple risk parity strategy is to allocate 1/3 to equities, 1/3 to fixed income and 1/3 to commodities. The underlying rationale is that equities perform well in robust markets; debt performs well in distressed markets; while commodities perform well in inflationary markets. An effective risk parity strategy is easy to articulate, but has proven difficult to implement in the real world. Nevertheless, the theory is sound, which keeps some fund managers engaged in perfecting the strategy.
4. LIQUID ALTERNATIVES STRATEGIES
Liquid alternatives include a broad range of strategies across asset classes and investment styles. They seek to provide a combination of return enhancing, diversifying, and defensive features. Unlike “illiquid alternatives,” the “liquid” category of alternatives allow for diversification with a duration risk that can be calculated, to anticipate asset value changes in the face of interest rate changes. These strategies invest almost exclusively in the public markets or in derivatives tied to the performance of those markets.
Liquid alternatives also usually have the flexibility to take either long or short positions; the latter seek to benefit from declining asset values. As a result of all these features, liquid alternatives may have different risk/return profiles than traditional investments, with varying levels of exposure to the equity market, as well as diversification driven by risk management. Liquid alternative strategies include the following:
⇒ Managed future strategies involve assembly of a diversified portfolio of futures contracts. While the complexity of futures — much less a bundle of futures – may be off-putting to most plan participants, the fact remains that futures investing offers proven opportunities for profit, as well as hedging.
⇒ Relative value strategies involve buying a security perceived as undervalued and selling short a similar security perceived as overvalued to take advantage of temporary differences in price. Importantly, relative value strategies dominate hedge funds, particularly the VIX option carry trade.
⇒ Event driven strategies seek to exploit mispricings that can occur in advance of or following corporate events, such as mergers, acquisitions, bankruptcies, and earnings calls.
By offering investment lineups that consider these four strategy categories, and by updating plan participants with market updates regarding each, we cover a wide spectrum of opportunities for investing success.