In this episode of the Modern Financial Advisor Podcast, host Mike Langford is joined by Arnim Holzer, Global Macro Strategist at Easterly EAB, for an insightful discussion on market volatility and the need to rethink traditional asset allocation models. They explore the historical context of Modern Portfolio Theory, its simplifications, and why its assumptions may not hold in today's economic environment.
The conversation delves into the instability of asset correlations during periods of volatility, the impact of macroeconomic conditions, and the importance of incorporating volatility-sensitive strategies into portfolios. Advisors can benefit from practical advice on how to use high Sortino ratio funds and strategies to manage downside risks and enhance client portfolio resilience.
The episode also touches upon the relevance of active versus passive management, the implications of the global pandemic on markets, and the importance of client perception of portfolio performance.
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Episode Summary
In the latest episode of the Modern Financial Advisor Podcast, we dive into the intricacies of market volatility with Arnim Holzer, Global Macro Strategist at Easterly EAB. This conversation couldn't be more timely, as many of the asset allocation fundamentals that financial advisors have held onto for generations may need reevaluation given current macroeconomic conditions.
The Evolving Landscape of Asset Allocation
Arnim shared insights starting with the history of modern portfolio theory (MPT), introduced by Markowitz in the 1950s. While revolutionary, MPT’s simplifications have led to certain assumptions that may not hold true in today's dynamic market. One such assumption is the stability of correlations between asset classes and returns over time. According to Arnim, these can be notably unstable when volatility spikes, posing risks that the original models did not account for.
Correlation and Volatility: The Hidden Risks
As Arnim explained, a huge risk in many portfolio models is their reliance on underestimated correlations, particularly between equity and fixed income. During periods of high market volatility, these correlations can unexpectedly increase, leading to synchronized downturns in supposedly diverse asset allocations. Arnim argues for a more nuanced understanding of asset behavior, especially under stress.
The Fee Focus and Passive Management Debate
Throughout the episode, Arnim emphasized the industry’s past fixation on managing fees, and the movement towards passive investment strategies. He raised concerns about how this shift, paired with an underappreciation of risk management, has affected overall portfolio resilience. While passive management has greatly reduced costs, it may inadvertently increase systemic risk by underestimating the need for active management in unpredictable markets.
Building Resilient Portfolios
For advisors, the key takeaway is the importance of incorporating strategies that mitigate these risks. Arnim suggests focusing on products that account for volatility spikes by breaking traditional correlation assumptions. He advocates for integrating funds that exhibit high Sortino ratios and offer disproportionate downside protection, enhancing clients' resilience in volatile times.
Practical Insights for Financial Advisors
Arnim provided valuable guidance on practical steps advisors can take to future-proof client portfolios. This includes considering funds that overlay options to protect against market downturns, and ensuring a balanced approach that still captures upside potential. He advises using tools to identify funds with strong upside-downside capture ratios, ensuring that even amidst volatility, a client's portfolio can withstand and thrive.
Final Thoughts
As markets continue to evolve with unexpected economic shifts, the conversation with Arnim Holzer reveals crucial insights for financial advisors. By embracing a strategic focus on volatility management, and rethinking traditional asset allocation models, advisors can better navigate the complexities of today's financial landscape.
For those interested in delving deeper into these strategies, Arnim’s expertise and resources through Easterly EAB provide guiding principles for adapting to these modern challenges.
Resources Mentioned In This Episode:
What If Financial Advisors Have Been Using the Wrong Methodology for Retirement Planning? - Steve Vecchione and Scott Schuebel of Statera Advisors were guests on the previous episode of the Modern Financial Advisor Podcast and they are taking a slightly different approach than Arnim’s to accomplish a similar goal for their clients. Their motivation however, is very similar… to protect their clients from market downside.
Dr. Zvi Bodie - Mike mentioned the the teachings and wisdom of his former Boston University Graduate School of Management professor . Dr. Bodie also the author of “Investments” which is the standard textbook used in business schools around the world.
Chapters
00:00 Introduction and Episode Overview
01:10 Guest Introduction: Arnim Holzer
01:24 Casual Conversation: Weekend Plans
02:21 Diving into Market Volatility
03:01 Challenging Traditional Asset Allocation Models
05:22 Flaws in Modern Portfolio Theory
06:27 Correlation and Volatility in Asset Allocation
16:06 Impact of Fed Policy on Market Correlations
24:00 Impact of the Pandemic on Inflation
24:55 Housing Market Dynamics During the Pandemic
26:13 The Fed's Response and Fixed Income Challenges
27:00 Volatility and Portfolio Management
28:36 Advisors' Role in Managing Volatility
31:25 Optimizing Portfolios with High Sortino Ratios
36:46 The Importance of Risk Management
42:40 Connecting with Arnim Holzer
44:20 Conclusion and Farewell