Macro Risk Advisors

The S&P 500 was up 32% last year and recently reached a new all-time high. Since the March 2009 lows, the market is up 180%. Despite this impressive rally, both institutional and retail advisors must contemplate how to protect client portfolio wealth as many sources of uncertainty remain. The risk environment has changed over the past several years. Banks can create instability, government debt is no longer seen as risk free, the China growth miracle is in question, and Central Banks are actively influencing the prices of assets. This is not your fathers market.

The growth of ETFs has been nothing short of tremendous. What started as a product designed to provide investors with broad equity or sector exposure in the US, the ETF landscape now includes a myriad of geographies (Europe, Asia) and asset classes (FX, rates, credit, commodities). Research consultancy firm EFTGI estimates that there are almost 5,000 ETFs globally with total AUM in excess of $2 trillion.

The five-year anniversary of the Lehman bankruptcy and onset of financial crisis is here and so too is the raft of opinion pieces around what caused the meltdown and how it is different this time.In a recent interview with Charlie Rose, when asked about the risk of another 2008 event, Morgan Stanley CEO James Gorman said, The probability of it happening again in our lifetime is as close to zero as I could imagine.

We review recent periods of financial market stress, which bring about elevated levels of asset volatility and during which investors are vulnerable to incurring substantial loss of capital. We illustrate that risk is determined both by the volatility of individual investments in a portfolio and the degree to which they are correlated. Often overlooked, correlation is a critical factor. Because assets become more correlated at the same time they become more volatile, we argue that the benefits of diversification often are difficult to achieve when they are most needed.