Market Volatility: Thoughts for Non-Profit Endowments in Turbulent Times
Mountaineering – It is often said that there are old mountaineers and bold mountaineers, but not many old bold ones!
If you get it wrong once, that’s the end of the road, so be smart, trust your inner voice, take calculated risks, and don’t be too proud to back away. While adverse outcomes for our investors at Verger may not be life and death, they can have a dramatic impact on an institution. Our goal is to balance bold decisions with strategies designed to mitigate risk and, most importantly, keep climbing.
Daniel Kahneman, the Nobel laureate in economics, observed what will sound quite obvious – people across all levels of wealth exhibit a tendency toward loss aversion. Many individuals view one dollar of loss as more significant than one dollar of gain. Or, in Kahneman’s own words, “the response to losses is stronger than the response to corresponding gains.” Things get tricky when equating volatility with risk or loss because volatility is not directional. The issue here is that while standard deviation counts upward and downward volatility the same, their impact on investors is dramatically different. You can lose money or make money when volatility is high, so our goal is to use volatility to the advantage of our clients while also managing the downside impact.
The human psyche has a very difficult time comprehending volatility and it is a concept that is widely misunderstood. Volatility is not fear. Volatility is not the VIX index. Volatility is not a statistic or a standard deviation, or any other number derived by abstract formula. Volatility is no different in markets than it is in life. Regardless of how it is measured, volatility reflects the difference between the world as we imagine it and the world that exists. Markets, and life, can be volatile and don’t only travel in one direction.
At Verger we like to think about short convexity vs. long convexity. A short convexity choice derives small incremental gains on the assumption of stability in exchange for the risk of substantial loss in the event of change. A long convexity choice is the opposite, requiring a small upfront cost, in exchange for robust and significant positive exposure to change. For example, speeding, smoking, consumer debt, not flossing, obesity, or taking a job for the paycheck rather than for growth, are all examples of short convexity behavior. You are long convexity when you seek to improve yourself through learning, exercise, healthy eating, networking, surrounding yourself with those who are smarter than you, traveling, and meditation.
As you can imagine, long convexity decisions are often better in the long-term, but appear more difficult to endure in the short-term. The current environment presents some unique challenges for investors looking to make long-term decisions as a result of heightened uncertainty and volatility. Until recently, the Fed was hesitant to normalize interest rates for fear that it would stifle growth and trigger a recession, but record inflation and artificially high valuations across asset classes have forced their hand. The result is an environment where the Fed has begun raising rates and shrinking its balance sheet just as GDP growth slows and inflation peaks. The resulting sell-off and accompanying volatility signal a collective realization among investors that the institutions we trusted to remove risk may actually be the source of it.
The heightened volatility and resulting investor behavior seem to illustrate that moral hazard is institutionalized in the price of risk. A new generation of traders has learned to buy every stock market dip, short every volatility spike, and re-leverage at the mere hint of government intervention. That reflex has, at least for the time being, been subdued mainly by a hawkish Fed and the fear of out-of-control inflation.
But volatility can provide optionality when you are anti-fragile. An anti-fragile investment portfolio possesses optionality. Optionality means the portfolio invests in strategies that may provide investor liquidity in most markets and allows them to make opportunistic investments when others are looking for buyers at any price. An anti-fragile portfolio allows its investors to sleep at night. It can have small losses from time to time but seeks to avoid catastrophic ones (black swans). During this period of change (economic, social, and political), heightened volatility, and constrained university, healthcare, and non-profit resources, we believe our work matters more than ever. We are proud of our all-weather, anti-fragile portfolio and how it has performed through this recent bout of downside pressure and volatility.
Looking ahead, we remain focused on providing a reasonable balance between participating in market advances and protecting capital during market declines. We think this is the best way to grow and compound capital over the long term. We have confidence in our approach, knowing that the rocket fuel that propelled markets over much of the last several years may have run out. Interest rates are no longer pegged at zero, the Fed plans to shrink its balance sheet, market volatility has re-emerged, and it is likely here to stay. We believe Verger is well-positioned to effectively navigate these challenges and will lean on our mantra to Protect, Perform, and Provide whether we are enjoying lofty vistas or navigating rocky slopes.
All investments involve risk, including possible loss of principal. Not all strategies are appropriate for all investors. There is no guarantee that any particular asset allocation or mix of strategies will meet your investment objectives. Diversification does not ensure a profit or protect against a loss. One cannot invest directly in an index, and unmanaged indices do not incur fees and expenses.
This article is being provided for informational purposes only and constitutes neither an offer to sell nor a solicitation of an offer to buy securities. Offerings of securities are only made by delivery of the prospectus or confidential offering materials of the relevant fund or pool, which describe certain risks related to an investment in the securities and which qualify in their entirety the information set forth herein. Statements made herein may be materially different from those in the prospectus or confidential offering materials of a fund or pool.
This article is not investment or tax advice and should not be relied on as such. Verger Capital Management (“Verger”) specifically disclaims any duty to update this article. Opinions expressed herein are those of Verger and are not a recommendation to buy or sell any securities.
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