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Ed Butowsky Investment Advisor

Internationally Recognized Wealth Manager

written by Ed Butowsky, February 21, 2012

As I study portfolios, I believe very few people are prepared for a
downward move in the world equity markets. Mark my words, in 25 years
of managing money, I have never been more convinced that we are on the
be brink of a rough equity market. Most investors are ill-prepared and
have not learned from the liquidity crisis. A properly managed
portfolio is like the military–always prepared.

A portfolio that is making money on everything at the same time is
poorly constructed. A properly managed portfolio should always have
some investments that are not doing well. If all of your assets are
going up together you should be concerned because when the positive
economic condition changes, you need to have some investments that can
go up.

Financial advisors and clients need to do a better job of protecting
portfolios against a downward move in the world stock markets. It is
virtually impossible to manage a portfolio today without having
non-correlated assets in the portfolio. Due to computer systems and
communication systems, most asset categories have become highly
correlated.

When the markets are going higher, people don’t seem to care because
generally speaking, most investors are owning investments that are
very similar. However, when the positive economic events that causes
these assets to go higher changes, everything in their portfolio will
drop simultaneously.

Prior to the mid-eighties, you could effectively have a portfolio that
consisted of US stocks, international stocks and bonds and still have
a low risk and well diversified portfolio. However, in recent years,
this type of portfolio would not be considered broadly diversified.

if you understand correlations, you can protect your portfolio and
your “nest egg” from a sudden drop due to any of the negative probable
outcomes that are on the horizon today. We measure the correlation
relationship between two assets as between plus 1 and minus 1. If two
assets have a high correlation (.85 or higher) this means that they
generally move up and down together. Today, 94% of all equity
categories ranging from large cap growth and value to micro cap, from
utilities to MLPs, from MSCI/EAFE to frontier markets are so highly
correlated that it is difficult to reduce risk by simply investing in
these.

The following table shows timed correlations for the past 20 years.

Bottom-line, advisors and clients need to study the correlation of
assets and be ready for what I believe to be an inevitable downward
move in the world markets.

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