The Merits of a Dynamic Investment Strategy

Global capital markets and risk assets are continuing to wrestle with a hangover from pandemic-induced stimulus. Decelerating growth, elevated inflation, and excessive volatility are among the natural consequences of the unprecedented fiscal and monetary support, and investors are now grappling with these inevitable realities.

The benefits of employing a dynamic investment approach featuring absolute returns, low volatility, and the preservation of precious investment capital tend to shine through in moments of market tumult, and portfolio performance over the past year illustrates this quite well. Portfolio actions implemented throughout the year have materially reduced risk exposure, prepared our portfolios for rising volatility, and captured profits in the energy sector. The result has been that performance among our Dynamic Strategies generally compares quite favorably against appropriate market indices, and our portfolio positioning has set the stage for us to deploy capital opportunistically should new opportunities emerge.

Key Points from the Third Quarter and Year to Date

With all the noise that permeates markets, it’s essential to step back from the day-to-day flow of economic data and global news and assess what’s really happening over time. Here are some select observations from last quarter and the year to date that get to the heart of the matter:

  • The S&P 500 was down 5.3% for the quarter, ending September down almost 25% year to date. Bond markets suffered as well. The US Aggregate Index fell 4.75% and is now down almost 15% year to date. And the conservative 60/40 portfolio consisting of these two benchmark indexes has declined nearly 20% year to date.
  • The Fed continued raising interest rates, with two 75-basis-point increases during the quarter. It has raised interest rates 300 basis points over the last seven months. In addition, it has begun to reverse quantitative easing, which, combined with rising rates, has driven the 30-year mortgage rate to just over 7% at the end of the quarter. It has more than doubled since the beginning of the year and is the highest in over 20 years.
  • Economic data and earnings expectations continued to show evidence of deceleration, and growth prospects deteriorated throughout the quarter.
  • The energy sector remains a bright spot, gaining over 2% during a challenging quarter and up 35% through the end of September. Energy remains a key overweight in our equity-focused portfolios.

The data convey the facts but don’t communicate the experience. The quarter was marked by a rollercoaster round trip for equities that witnessed an extreme bear-market rally followed by a peak-to-trough decline of 17%. While this demonstrates the volatility that has transpired in the equity market, it doesn’t capture the challenges in fixed income. Historically, bonds and equities have offered diversifying benefits, but 2022 is now the only year in the last 100 that bonds and equities are both suffering double-digit declines.

Our strategic approach to long-term compounding has largely sidestepped much of the damage. Client portfolios invested in our Dynamic Strategies have generally declined single digits through the third quarter – far eclipsing many market indices. We’ve largely avoided the risks of high equity valuations by focusing on value, quality, and the rising energy sector. Further, by limiting maturities we’ve largely sidestepped the carnage in bonds. Finally, our healthy position in cash and short-term treasuries has added further protection and is a source of “dry powder” as new opportunities for profit begin to emerge.

Illustrating the Benefits of Dynamic Investing

The accompanying chart illustrates the potential advantages of a well-executed dynamic approach in volatile environments. It compares the journey of a hypothetical portfolio during a period when financial markets sharply decline and then eventually recover.  Market returns are illustrated on the left, showing an initial decline of 25% — similar to the return experienced this year by the S&P 500. This is followed by an eventual 33% recovery, which is the mathematical return required to get back to even and can take years to occur.

On the right is an illustration of the possible journey of a dynamic portfolio that proactively becomes more defensive and limits losses during this falling market and then takes advantage of attractively lower market prices to adjust its stance and become more offensive. The chart illustrates returns during the recovery stage ranging from 20% to 33%, which are 80% to 100% of the S&P 500’s return in this example. All carry the portfolio to new heights.

The point of this illustration is that there are potentially both shorter-term and longer-term benefits to dynamic portfolios that successfully reduce losses during meaningful falling markets. In the short-term, values are preserved, the return needed to recover is smaller, and the time frame to recovery can be shorter. In the long-term, the portfolio begins the recovery phase from a much higher base. This means that it can quickly move beyond recovery and resume advancing portfolio values even if returns don’t match market returns as prices recover. We believe this is the advantageous position we find ourselves in now.

Mining for Opportunities

What may be lost in the accompanying chart is that a well-executed dynamic portfolio means far more than just being in or out of the market. Ours is a constant search for investments that offer compelling returns over the next 18-24 months. Even in broadly declining markets, there can be pockets of opportunity. The energy sector of the S&P 500 is a prime example. In the face of a slowing economy, it has very favorable supply-and-demand fundamentals and a very strong earnings outlook. Both have contributed to strong year-to-date returns, which have helped buoy overall portfolio returns in our equity-focused strategies.

As mentioned, we continue to hold significant amounts of “dry powder” and remain vigilant looking for opportunities to put these resources to harder work at attractive levels. The 18-to-24-month outlook for the defensive assets we hold is always positive, and their prospective returns increase as interest rates rise. So, to reduce the size of these positions will require our finding investments with compelling positive outlooks that eclipse these returns with a high margin of safety. It’s likely these will not all come at once and, like energy stocks, some opportunities may surface before the broad markets bottom.

In equities, this means buying tomorrow’s earnings at attractive prices. While equity valuations are now much lower than they were at the beginning of the year, they may have further room to drop, as analysts have been slow to revise earnings forecasts lower in the face of a slowing economy and possible recession. This is not atypical, but it means the prudent investor must look past current valuation multiples and consider where future revenues will land. Therefore, we prepare multiple earnings scenarios and continuously update them as new data are received.  Right now, our work suggests we’re likely to see opportunities to purchase at better prices and more compelling future returns by being patient, yet ever vigilant.


In general, we believe portfolios are now eclipsing relevant market indices by enviable margins, and we are very pleased with our relative performance. Should financial markets continue to weaken, this difference in return is likely to widen. While this is heartening, our true focus is on delivering the absolute positive returns you need to meet your financial objectives. We believe the advantage of our current positioning gives us that ability.

We thank you for the privilege of allowing us to guide your assets in these challenging times. As always, we welcome your questions and observations.