It’s late in the market cycle. Do you know where your portfolio is?

In our most recent version of our Global Market Outlook, our strategist team points out again just how late we are in our current market cycle. U.S. equity markets, for example, have had steady growth since they bottomed out during the global financial crisis and look expensive by most metrics. And when it’s this late in the cycle, the next turn of the screw could be a major correction.

Savvy investors need to know how much they stand to lose in an adverse market and be ready to react. But acting appropriately requires a deep and detailed view of current exposures within a portfolio as well as an understanding of how those exposures may respond under stress. If you’re not sure where you are, how do you know if your next move will add value or cause harm? How can you calibrate positions without understanding the risk/return trade-offs they represent? This level of clarity—of truly knowing what you own—is not a nice-to-have. It’s foundational.

How street-level is your knowledge?

How deep does your view inside your portfolio need to go? Think about it this way. Say you’re taking your daughter to her soccer game. The clock is ticking and you’re driving to a field that you’ve never been to before. Even with the best map available, having the address for the field is not much good if you don’t have a clear idea where you are now. Every navigational app worth its salt tells you three things: where you are now, the destination and the best route between the two.

The same holds true with investing, with a vengeance. Knowing where a portfolio is now is essential and far from straightforward. Without that understanding, intentional portfolio management is impossible and unintended risks can creep into your portfolio. Grasping and managing positioning when using multiple mutual funds or sub-advisers compounds the difficulty of this problem and also compounds the importance of finding a solution.

At Russell Investments, we believe that detailed, real-time knowledge of what you own is a condition for taking action. When we manage a multi-asset portfolio, we see ALL holdings on a daily basis. This street-level view is a necessary foundation for any active investment process. But this clarity is not easily achieved. Every year, we invest heavily in data systems and analysis that informs our portfolio managers on where their portfolios are positioned, down to the single-security level. We’ve also found that most of the industry’s off-the-shelf analytics tools are designed more for individual security selection or for single asset class views rather than for a total portfolio view that would incorporate multi-dimensional asset and risk exposures, in addition to impact by strategy and sub-adviser. So we’ve also developed our own proprietary tools that allow us to view the portfolio as constructed with the independent building blocks we use. This information enables us to proactively readjust as we see fit. Without this information, we would be flying blind.

A total-portfolio view

Along with a clear view of all the individual constituents, it’s equally important to have a single, integrated view of the total portfolio. Keeping these two extreme ends of the knowledge spectrum in sight simultaneously translates into informed, actionable factor views that empower real-world responses to market conditions.

If you’re responsible for a portfolio, think about your current ability to anticipate and respond to these scenarios: If the Japanese yen took a sudden dip in value, would you know how much money you would stand to gain or lose? You might know what would happen if the U.S. Federal Reserve (the Fed) raised interest rates, but how exposed are you to interest rates around the world? How much would not only your bonds contribute, but what about holdings in real estate securities (REITs), infrastructure and financial exposures within your equity portfolio? How would these be affected?? How impacted would your portfolio be by an energy-sector downturn—not only through commodities held, but also by energy stocks and international markets that are more heavily exposed to commodities (think Australia and Canada) and their currency markets?

Shocks to the system

Knowing where your portfolio is and how it might behave is never more important than late in the economic cycle. The question is not if something bad will happen, it is only when. As the saying goes, history doesn’t repeat itself, but it rhymes. So then, to stress-test our own portfolio knowledge, we run test scenarios, often based on actual, relatively recent historic market events. Keeping a clear eye on all of a portfolio’s constituent parts, we may see how it would respond if, say, the Fed raised interest rates by 100 basis points over a six-month period. If this sounds too remarkable to be realistic, keep in mind that in March of 1994, U.S. Federal Reserve rates were at 6.25%. By November of that same year, those rates rose to 8.5%.

Using such real-world examples as market shocks, we believe we can prepare for the universe of highest-likelihood future events. We can judge whether our positions are consistent with what we think will happen and, furthermore, we can fine-tune the size of the positions to make sure we are not risking too much on any single market outcome. Risk management requires this sort of multi-scenario analysis. This is especially important in times like today when markets have been relatively quiet. We must constantly remind ourselves of what may happen in the less benign markets to come. But this is only possible if we have a clear view of current portfolio exposures.

In my next blog post in this series, I’ll talk about the second step: Know where you want to go. But that second step is wholly dependent on a clear portfolio view. Successful investing at the total-portfolio level requires a powerful toolkit. And knowledge is power.