Maverick Risk: The Market Rewards Discomfort

J.J. Abodeely (occasional commenter on this blog) had a great post Monday about Maverick Risk. The opening quote from Rob Arnott tells you some about what the term means: "The market doesn't reward comfort. It rewards discomfort."

J.J. explores different ways to be unconventional in terms of exposure, weightings and asset classes. Also noted is the synonymous term coined by GMO: career risk. Going with the crowd has an element of comfort because it is better to be wrong in the same manner as everyone else than to be wrong all by yourself. Maverick Risk means being able break free of the fear of being wrong by yourself.

While I might be reading what I want to read, I think this idea in the big picture sense has been a big focus of my writing and more importantly built into client portfolios.

The way I would suggest individuals apply this Maverick Risk is to be willing to entertain allocations that most people will not use. There needs to be an assumption of being willing to spend a certain amount of time on the task.

The mainstream (you can take that as both media and most of the professionals you see on TV and read on the web) is very slow to embrace anything new. Morningstar still doesn't understand ETFs. How many investment managers come on TV recommending domestic mega cap stocks no matter what is going on in the world? How many times have you heard "this will be the year for Japan?" Probably a little less knowable but how many managers do you suppose continue to have portfolios that look a lot like SPY/IWM/EFA?

Think about the last five or 10 years and what has done well and what has done poorly. Chances are that if you underweighted the same old-same old you did much better than the comfortably wrong crowd. I would refer you to Bespoke Investment Group's decade numbers for all the markets in the world. I've made the point repeatedly that as the S&P 500 was going down 24% on a price basis and the EFA was annualized out to about 3.5% per year gain there were plenty of markets that had normal decades and plenty others that had much better than normal decades.

Likewise there were some themes that might not have been mainstream five or ten years ago that have done very well and are likely to continue to do very well but broad funds don't capture them. Over the years I have written about all sorts of themes and countries that not too many people have exposure to. Everyone I've ever explored came from something else I read that seemed interesting for one reason or another, some of which I have implemented into client portfolios.

Two ideas I have mentioned a couple of times have been Mongolia and cement. Van Eck has an ETF for Mongolia in the works and if it turns out to be very heavy in resources (some combo of energy and materials) then it might make sense to add that in as a means of increasing volatility of the portfolio at such a time that more volatility is desirable. While there is no cement ETF in the works that I know of, it is not impossible that there could be one but as I sit here now it is not clear to me that cement, as part of the materials sector, would be a better place to be than mining, metals or agriculture. To the extent cement is part of the infrastructure theme, of which I am a big believer, I would rather access the theme via some combo of industrials and utilities, which are large exposures in the iShares Emerging Market Infrastructure ETF (EMIF) that we own for clients.

All of this plays into top down portfolio construction, at least I think it does. Most of the decisions that I've made in the portfolio over the years have been very obvious when thought of in the big picture. I've joked before about how many times are you going to read that the housing and mortgage markets in Europe and the U.K. are deteriorating rapidly before you take action (obviously pertains to several years ago)? If you know the track record for a sector growing larger than 20% of the SPX is very bad aren't you going to underweight it? If a country has very little debt and an abundance of something the world must have aren't you going to figure a way in?

The term Maverick Risk has not really been a front burner term in this process. When constructing a portfolio of narrow products it seems only logical that time should be spent figuring out what to avoid, it just makes the task easier. Likewise if you can isolate some very obvious themes were money is going to flow. While maybe this is Maverick Risk, I actually think of it as being less risky.