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Caution for 2007.


A sample of the headlines in 2007 so far read like a scary movie trailer in the days before its launch.

“Cautious Strategists.” “Volatile year in markets.” “Commodity prices drop.”

The Research is much the same.

“Late in the game.” “Rates to rise.” “Severe Correction.”

And then there’s the other side.

“Good time to be a contrarian.” “Expect gains on rocky ride.”

My favorite: “Still bullish, [but] rising market can’t go on forever.” In other words, “if the market goes up, or down, I told you so …”

Investors can easily obtain the economic backdrop and market performance over the last five years or so. Oil, commodities, the Loonie, most markets have done well. Some very well.

Now the key words we read are ‘slower’, ‘dropping’, ‘correcting’. The conservative interpretation is that sideways or down is more likely than up.

With so many conflicting signals, how does one manage an investment portfolio?

One strategy might be to ignore the headlines and enhance the prospects for your investment portfolio in 2007 by preparing it for ALL environments.

That strategy is diversification.

A properly constructed portfolio will be broadly and globally, diversified. It will have both traditional and alternative assets.

Traditional assets are Canadian, US and International Cash, Bonds and Stocks. They form the core – usually the bulk of an investment portfolio.

Alternatives are other than traditional. Like the satellites to the core. Ideally, alternatives are non (or low) correlated asset classes, regions, currencies or sectors that complement the core. At any one time, they MIGHT include any one or several of Real estate, Gold, Bullion, Asian bonds, US cash, Commodities, Emerging markets, Real return bonds, small cap stocks or (dare I say it) perhaps even Income Trusts.

In measured positions, alternatives can provide a portfolio with either upside oomph or some down market protection. Alternatives complement rather than replace existing holdings. (A measured position, in a single alternative, is, say, 2 ½% or 5%). This means adding positions that may not have done as well or are expected to do relatively better. Or it means cutting back, taking profits on those that have done well.

Broad, global diversification and non-correlated assets will help provide some zig should your existing investments start to zag. It is this offset that allows you to participate in many opportunities but also helps protect your overall portfolio in a down market. Not all pieces of a portfolio will perform at the same time. The gains in one asset offset or help to moderate the decline in other assets. With proper portfolio construction, this blend of exposures helps to smooth the ride. This is the value of diversification. It allows us to meet our objectives but let’s you sleep at night.

A few weeks does not a year make. But, so far in 2007, the downs are down more than the offsetting ups are up. If January is any indication, then, yes, caution indeed.

(source: iShares.com, 26 January 07).

Originally published in the Business Thompson Okanagan news, February 2007.

Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.

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