December 5, 2019 | By: Bill DeRoche

Perfect Asymmetry

2.5 min read

Why minimizing losses can lead to bigger gains in an investor’s portfolio.

 

The late stage of a market cycle is always a difficult period for investors. While gains can still be had and often end up being significant, they are usually accompanied by increased volatility and the growing prospect of a major correction. But this is also the kind of environment that well-diversified portfolios are made for and those who complement their mix of stocks and bonds with non-correlated asset classes and long-short strategies may benefit the most.

In fact, due to the asymmetric nature of investment returns, investors who use alternatives to help minimize potential losses in the short term could end up having a much easier time outperforming in long run.

Take for example, a portfolio that loses 50% in value, a rare occurrence perhaps, but one that many investors experienced during the financial crisis and dot.com bust. It would need to gain 100% in a subsequent rally just to break even. Now consider a portfolio that loses 40%. It only needs to return 67% to get back to square one, while a portfolio that falls 30% requires an even smaller subsequent gain of 43%.

 

In other words, the larger the loss is, the more significant the rebound needs to be. And by limiting losses, investors also start with a higher base when the next market turn begins, leaving them better positioned to outperform in a full cycle of sell-off and recovery.

Furthermore, the ability to avert large losses also goes a long way in keeping people invested. Market corrections or extended slumps in individual stock prices too often lead to poor decision-making with investors either trying to win back what they lost by taking on more risk than is suitable or abandoning their investments all together and negating the opportunity to participate in future gains.

That is why a diversified portfolio that includes a variety of asset classes and strategies for minimizing losses is so important. It has the potential to balance growing risks with opportunities for return, while offering the possibility of a smoother, more favourable experience that can help overcome the emotional highs and lows of being an investor.

Breaking even: Large losses require larger gains
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Source: AGF Investments Inc. Illustrations for example purposes only.

Bill DeRoche is Chief Investment Officer, AGF Investments LLC, and Head of AGFiQ Alternative Strategies.

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