The start of 2022 has seen a strong reversal of recent trends in investment markets. Oil ended 2021 around the USD$70 mark and three months later is pushing past USD$120 a barrel. Much of this change has come in the first week of March. Share markets globally have seen large falls in the first months of 2022. There has been a strong shift away from so called growth companies with many of the growth style fund managers giving up their gains of 2021. 

The headline rationale for these movements, as attributed by media pundits, is of course the sharp rise in inflation across much of the developed world and the despicable invasion of Ukraine. If history is a guide, we should expect these events to influence investment markets for some time to come.

The question is… should you be adjusting your portfolio in response to these increased risks? 

Portfolio management requires a little humility. Fundamental to this approach is to recognise no one can accurately and consistently predict the future. Perhaps the best we can do in the short term is to recognise and prepare for specific risks, but equally we need to understand these risks will evolve. Invariably hindsight demonstrates the best forecasts and the actual outcomes are rarely the same.

At its core an investment portfolio is a basket or pool of assets. The purpose is to either grow in value (accumulation) or to provide you with an income stream (decumulation). The assets available to fill a portfolio are limited to stocks, bonds, cash, property, infrastructure and alternatives. 

Traditional portfolio theory suggests that when you are looking to accumulate you will have a greater proportion of growth assets such as stocks and property. Conversely if you are looking to fund your lifestyle expenses (decumulation) you might have greater income producing assets.

Income assets such as bonds and perhaps cash will demonstrate lower volatility. They also provide lower returns. In 2010 you could get 5% for cash, today you can get 0.1%. A portfolio holding bonds and cash would have provided you with the required 5% return 10 years ago - but not today.

The current low interest rate environment has twisted traditional portfolio theory increasing the focus on risk assets (largely equities) to provide income. When the purpose of a portfolio is to provide an income of 5% of the portfolio balance, it simply is not feasible to allocate large portions to defensive assets. Disregarding short term tactical allocations, a decision to hold all cash is a decision to draw down your capital to fund lifestyle expenses.

So, it follows to get the required returns we must also experience more volatility. Textbooks and media will portray volatility as risk. We agree that volatility can be scary, but risk should be viewed as a permanent loss of capital not volatility. 

A portfolio in decumulation that has sufficient cash to fund required income payments means you are not a forced seller of growth assets. When you are not a forced seller your portfolio rising and falling should not materially change your day. Volatility is even less scary if viewed over a longer time. Many seasoned investors will view volatility as opportunity. 

It is very rare to witness an investor with the skills and foresight to see risk and consistently execute exit and re-entry strategies. We countenance against trying to time market movements. History is littered with bad experiences from those that try. There is also the challenge of understanding where your risk asset actually is. If inflation indeed creates successive interest rate rises you may find more risk has been lying in wait for you in traditionally stable bond portfolios.

Portfolio management is rarely an all or nothing approach, it is measured and subtle. Decisions must be made against the personal risk appetite and the overriding purpose of the portfolio in question and never in haste. If you are considering large changes to your portfolio, it may be worthwhile discussing your ideas with a seasoned investment professional before you commence.