As advisors, we know about the different kinds of risk with which investors must contend. Business risk and liquidity risk are the two most common challenges associated with investing in individual securities. Such risks can be mitigated, or even avoided, by strong research, analysis and good advice.

One way to hedge against business or liquidity risk, of course, is to write options, if available, against your position, pocketing the premium as a way to enhance yield or reduce capital loss.

My commentaries, however, look at the broader macro-economic and market conditions and, by extension, are concerned with that rather large elephant in the room:
market risk. There is a risk that an individual asset will fluctuate with the market regardless of its particular fundamental merits. The risk of market variability is always there, of course, and will apply to some degree to all securities in a given market.

In a portfolio context, market risk can be mitigated by allocating assets in a mix that best reflects your tolerance for risk while still working to achieve your financial objectives.
This often boils down to a simple top-line decision on percentage allocation to each of cash, fixed income and equity.

It’s not a new concept, but it is absolutely amazing how often key investment principles are thrown out the window when investors are offered a deal that seems too good to pass up. The trouble is, such offers are often also too good to be true.
Shell-shocked investors are afterwards left with disappearing or bankrupt investments and a portfolio with more holes in it than Swiss cheese.

It has been my experience that investors are beguiled by the word “guarantee.” Very basically, any kind of a guarantee comes with a price-tag, and a fairly hefty one. The price may be in the form of an exceptionally low yield, in the case of securities such as guaranteed investment certificates or treasury bills. Other guarantees, such as those on segregated mutual funds and other principal-protected investment vehicles, come with high built-in costs in the form of steep management expense ratios.
Any guarantee worth the paper it is written on implies a trade-off in performance. The guarantee has to be paid for, somehow. If it doesn’t, or if it purports not to, or if the guarantee is not perfectly obvious and documented, then take your money and run.

The one thing that is never guaranteed is the way in which financial markets will move whenever U.S. Federal Reserve Board chairman Alan Greenspan makes a speech.
It could be, then, that a certain complacency has set in, because Greenspan’s semi-annual testimony before the Senate in mid-February fell on deaf ears as far as the markets were concerned.

Greenspan focused on the conundrum of low long-term interest rates, which he characterized as a “short-term aberration.”
Bond markets were singularly unimpressed with his concerns, as 10-year Treasury notes saw only a brief bout of tepid selling before buyers jumped in to push yields back down again.

It’s unusual for Greenspan to admit to being puzzled about things financial, but “conundrum” was his own word. He posited two possible reasons for the recent downward pressure of long yields: Asian central banks continue to buy U.S. bonds in an effort to keep their currencies low, and long bonds are hard to find. Falling mortgage rates are making mortgage refinancing and paydowns easier, having the knock-on effect of reducing the supply of long-term bonds.

Another explanation is that the Fed has done its job too well, imposing rate and price stability to such a degree that investors are settling for a smaller risk premium at the long end of the yield curve.

Meanwhile, Bank of Canada governor David Dodge has weighed in with his own policy speech in Vancouver. He emphasized that the central bank’s policy is to target inflation, not exchange-rate movements, although he did warn again that a strong C$ would continue to dampen economic growth.

Dodge also said that consumer demand will probably remain strong, and make an even greater contribution to economic growth than it did last year, adding two percentage points to economic growth this year. Interest rates would eventually have to rise, he added, but the pace of rate hikes would be slowed by factors beyond Canada’s control. This would have a negative impact on economic growth,
specifically continued weakness in the US$.