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Active Risk Management

We believe investors often overlook active risk management and have followed suggestions that they should go on their own to save on management fee. We are confident that our level of dedication and expertise goes beyond the potential savings an individual investor may realize by ‘Do-it-Yourself’ investing. Low fees are not synonymous with riskless investment strategies. In fact, in the long run, investors who have hired a financial advisor or a portfolio manager have had better results with higher return than the other alternative. Risk management and fiscal investment efficiency may have a large responsibility for this difference. Unfortunately low fees, on their own, do not protect ones portfolio against a downturn and only active management can mitigate the risk. As wealth portfolio managers, we cannot predict the future but we can, at the very least, anticipate and prepare for the outcome using extensive research and practical experience.

Firm Philosophy: Debunking Myth

Much can be said about risk!

Risk is simply too multidimensional to be measured by a single number.. For many, it is simply an event that destroys ones wealth. Unlike many investment firms, at Montag Private Wealth, we begin our client relationship by talking about our clients’ target risk level before getting into target returns. This ensures that we can determine a comfort level of volatility in relation to the expected return while assessing the likelihood of loss, and design investment policies aimed at managing this risk.

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Firm Philosophy: Debunking Myth

Much can be said about risk!

Risk is simply too multidimensional to be measured by a single number.. For many, it is simply an event that destroys ones wealth. Unlike many investment firms, at Montag Private Wealth, we begin our client relationship by talking about our clients’ target risk level before getting into target returns. This ensures that we can determine a comfort level of volatility in relation to the expected return while assessing the likelihood of loss, and design investment policies aimed at managing this risk.

There are many risks which may be unknown to potential investors including: regulatory environments, changing correlations between assets, changes in inflation, new assets, debt cycles and herd instincts that could lead to significant market volatility. Risk can also include the inability for investments to match future cash flow needs or large losses that cannot be recovered. It is up to the investor to understand what risk they want managed, standard deviation or shortfall risk, and how long they can hold that risk. This is why it is crucial for the risk discussion to take place at the onset of an investment.

At Montag Private Wealth, we strongly suggest multiple assets allocation model because not every asset has the same sensitivity to the same risk factors. Risks can be managed by adjusting portfolio holdings to the various states of long-term macroeconomics and debt cycle trends. With our diverse set of tools, we know normal return and risk profiles can be adjusted through the use of options and alternative investments. Hence, discretion in the asset allocation process is paramount for us.

“Most high net worth people have friends and neighbors who own stocks and bonds; very few own private equity, real estate hard asset or commodities. Going beyond stocks and bonds is for many investors a ‘no-man’s-land’.” Post Modern Investment: Facts and Fallacies of Growing Wealth in a Multi-Asset World, by Garry B. Crowder, Thomas Schneeweis and Hossein Kazemi (Nov 8 2012)

We at Montag Private Wealth can guide you into this unknown territory with confidence.

We believe that the addition of a range of other investment classes can offer more than the traditional stock and bond portfolio. This means greater access to return opportunities that may not exist in the stocks and bonds space.


Diversification

Investors who believe that a portfolio is well diversified if it includes equity and bonds should think twice. The fact is that the correlation of returns between a 60/40 portfolio and a 100% equity portfolio over the last 15 years has been 0.99.

Let’s share our vision of an asset diversifier:

Table 1 shows traditional portfolio diversification.

Table 2 shows what we consider broader asset allocation and a portfolio diversifier, which a wealth manager rarely offers.

Table 1

Typical 60/40 Portfolio

Table 2

Typical 60/40 Portfolio


Risk-parity

What is risk-parity? It is actually a strategy that, in the long run, may - by its construction -provide equal risk exposure to assets that typically perform well in different economic environments. It is essentially an allocation of market risk equally spread across asset classes that could include stocks, bonds, commodities and other asset classes or strategy diversifiers.

The use of risk-parity strategy makes a lot of sense. However, given the use of financial leverage in this strategy, we have to question the timing of it, especially in relation to the potential increase of interest rates going forward. The strategy implies more prudence and discernment in this context. Investors should keep in mind that a 60/40 portfolio split does not carry a 60/40 risk per se. It actually can carry more risk due to the contribution from stocks in the portfolio. The return adjusted for risk is something any investor should be aware of and at Montag Private Wealth we are particularly mindful of what this means.

The 60/40 Portfolio

60/40 Portfolio by Risk Contribution


Leverage

Leverage is a tricky concept. Almost every investor has some and almost everyone is weary of it. The average debt-to-equity ratio of companies in the S&P 500 is ~1:1, on average. So owning a share of Caterpillar or GE for example is the equivalent of having assets under leverage in your portfolio. Leverage is an excellent tool when it is strategically used to increase returns but it can also increase risk. The common misconception that Montag Private Wealth wants to debunk with leverage is that most people think a levered asset is always more risky than an unlevered asset.

Research Driven

Montag Private Wealth sources its investment ideas through extensive research performed on all the assets included in the portfolios. We concentrate on the capital structure of companies and focus the majority of our time on new investment ideas by analyzing common and preferred shares of companies as well as their debt, which might include their convertible debentures.

We always look at options available on stocks that we are analyzing to see if there is an opportunity or a way to buy or sell options (call, put) or do other option strategies to enhance the performance or the yield.

Our investment style is agnostic and we review all market capitalization (size and location) when comes time to finding good investment ideas.

Our research process is qualified as bottom-up but we are mindful of the macroeconomics cycle we are in before investing. We are sensitive to a top-down approach and we also use a quantitative approach to accelerate our company research and delve into new investment ideas.

We are also more inclined to look at investing in companies that adhere to a sustainable principle of doing business.

We see sustainable investment as risk management and risk mitigation but, more importantly, a way to achieve long-term superior financial returns for our clients. We believe this is not only prudent but indispensable. By incorporating the notion of sustainable investment into our research process, we intend to meet criteria that many leading-edge pension funds, foundations and endowments have factors into their investment strategies. The competitive landscape for business is changing in unprecedented ways and at a rapid pace. That is true in many sectors from real estate to banking and energy to automotive.

Traditional Versus Non-Traditional Investments Explained

There are many differences between traditional investments and hedge funds. The added value of hedge funds comes from the offer of a diverse source of risk-adjusted returns. These funds also target long-term capital preservation regardless of broad market moves. To thrive, traditional investments are dependent on a market going in one direction namely ‘up’ for equity and interest rates going ‘down’ for fixed income. In a portfolio context, it might be beneficial to allocate money to hedge funds or strategies that mitigate risk in an equity downside or fixed income increase interest rate environment. The intent is reducing the correlation to equity and fixed income bear markets as well as reducing the volatility and overall risk profile of the portfolio.

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Traditional Versus Non-Traditional Investments Explained

There are many differences between traditional investments and hedge funds. The added value of hedge funds comes from the offer of a diverse source of risk-adjusted returns. These funds also target long-term capital preservation regardless of broad market moves. To thrive, traditional investments are dependent on a market going in one direction namely ‘up’ for equity and interest rates going ‘down’ for fixed income. In a portfolio context, it might be beneficial to allocate money to hedge funds or strategies that mitigate risk in an equity downside or fixed income increase interest rate environment. The intent is reducing the correlation to equity and fixed income bear markets as well as reducing the volatility and overall risk profile of the portfolio.

Managers of traditional investments have limited access to financial instruments and hedging techniques. They also have a relative return objective and aim to outperform a benchmark. They aren’t seeking absolute return. Very often, the portfolios are fully invested and the incentive fee is more tied to the amount of assets in the portfolios. Managers are rewarded for increasing the assets under management, and they rarely have investment in the funds they manage or the same investment of their clients.

Managers of hedge funds have access to a wide range of financial instruments and investment techniques allowing them to reduce risks and take advantage of pricing inefficiencies. Hedge funds aim to achieve risk adjusted absolute returns regardless of the market environment. The managers can maintain a high level of cash in the portfolio if opportunities are lacking. Incentive fees are based on the asset under management and the funds’ absolute performance. Redemptions of the funds can be less liquid than traditional investments and depend on the underlying investments in a given strategy. Managers of the hedge funds invest their own money and bear the same risks as their clients. The transparency of some hedge funds may be more of a concern compared to traditional investments especially when it isn’t domiciled in regulated jurisdiction.


What does risk management mean to Montag Private Wealth?

Many take the ‘do-it-yourself’ route to save money. But do we really think people who don’t see finance as their specialty can really assess the risk inherent to their portfolio? We often hear ‘go the passive way’. It may be cheap but cheap doesn’t mean it’s risk-free. Does anybody get it? Low fees do not protect your portfolio against a downturn. Only active management can mitigate the risk. As a wealth portfolio manager, we cannot predict the future but we can face it knowing preparation and research accounts for 50% of the success in money investing. People can blindly rely on chance but this can also turn on a dime. We are aware of different risks that our clients are facing and we try to balance those risks by constantly monitoring their asset allocation to enhance their return and meet investment objectives. These risks can include:

Opportunity Risk

There is always a risk of not being invested or not achieving as much return as was available. We are more in the trade-off zone between avoiding any capital risk and assuming greater opportunity risk by giving up the returns available in more risky assets like equity versus GICs. A good example is of a portfolio manager who decides to increase the cash level assuming more opportunity risk and avoiding more capital risk. Completely avoiding one asset class like equities would also be assuming more opportunity risk.

Benchmark Risk

Is there a Benchmark Risk? Yes, especially for a manager that works on traditional investments. Having a return that is significantly different from the benchmark against which the portfolio is measured. It isn’t an investment risk but rather a governance and board reporting risk. However, as a wealth manager, not beating the benchmarks (especially when the benchmark goes down) is less important than achieving client investment goals. This means that our main concern is achieving risk-adjusted absolute returns.

Capital Risk

Capital Risk is the risk an investor may lose - all or part of the principal amount invested. With diversification in each asset class and more securities included in the portfolio, a manager is able to reduce the potential of any single loss. Moreover, liquidity (capacity to sell an asset when needed) also depends on the portfolio diversification in multi stocks, bonds or other assets that mitigate risk of a single securities going down.

Purchasing Power Risk

The purchasing power risk is the loss of value due to inflation. In other words is the chance that the cash flows from an investment won’t be worth as much in the future because of changes in purchasing power due to inflation. Bond holders are especially at risk if inflation starts to increase. They will see their purchasing power erode and may actually achieve a negative rate of return (if we are factoring in inflation).