Risk Labels Can Be Misleading

Risk Labels Can Be Misleading

Posted on July 16, 2018

Market State 1- Bullish (4 days):  The market, as measured by the S&P 500 is now in Market State 1.  According to studies performed by Canterbury Portfolio Analytics, the most new market highs occur in Market State 1.
Market State 1 characteristics are as follows:

CVI 60: The Canterbury Volatility Index (CVI) continues to be low and decreasing.  Low/decreasing CVI is a Bullish characteristic.  Bear markets do not happen at low levels of CVI.  When CVI is within a rational range (less than 90), drawdowns are limited to a normal bull market correction of about 10%.

One of the common tenets of traditional portfolio theory is the risk/return relationship.  This conventional wisdom states that one’s willingness to accept more risk is required to produce higher returns over the long-run.

Canterbury Portfolio Analytics has produced several studies on the risk/return relationship. We have produced empirical evidence that the opposite is true. Markets and securities with high and increasing volatility tend to experience larger declines in value and would tend to be a bear market characteristic

Achieving high long-term returns come as a result of years of the magic of compounded returns. For example: $200,000 doubles to $400,000, to $800,000 and $1,600,000, and so on and so forth. The killer of compounded returns is large declines in the portfolio’s value which comes from accepting more risk (volatility).

The price of all liquid traded markets and securities assets will fluctuate because of the changing supply and demand for the shares. All securities will eventually experience periods of high volatility and sharp declines in value. These declines will sometimes even occur in the face of good earnings from the underlying company.  Therefore, the practice of assigning a risk label, on an asset class, would be futile.

For instance, let’s compare small-cap growth stocks to large-cap value and 7 to 10 year treasury notes.  According to conventional wisdom, bonds should be less risky than value stocks and small cap stocks would be even more risky. The following charts will show the reality of which has been risky and which has not over the last year:

Source: AIQ

Based on the charts above, small-cap growth would appear to be much less risky than both large-cap value and 7-10 year treasuries.  Small-cap growth has not only had a smaller drawdown, but has also had more stable volatility according to the Canterbury Volatility Index. In addition, small-cap growth has been making money and is near a new all-time high, while both 7-10 year treasuries and large-cap value are nowhere near new highs.  Small-cap growth has been achieving a higher return on less risk.

Bottom Line:
All liquid traded securities will go through both bull and bear markets.  Therefore, assigning a risk label to any asset class is dangerous.  A bond-only portfolio would have performed poorly over the last 2 years, and on much higher risk than a portfolio consisting of growth stocks.  Conventional wisdoms can be dangerous to portfolio management.

At Canterbury, we focus on Adaptive Portfolio Strategy.  This idea rejects conventional wisdoms like the risk/return relationship.  Adaptive Portfolio Management allows rotation and allocation adjustments to keep your portfolio in a bull Market State. 
Canterbury Investment Management: Tom Hardin

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.