Michael Oyster - Ask if it is a Compensated or Uncompensated Risk

Michael Oyster is the founder and CIO of Oyster Capital, a multifaceted investment advisory organization dedicated to providing customized solutions for planners, advisors, investment managers and asset owners to assist in the achievement of all types of investment goals. Previously, Michael served as senior quantitative analyst with options advisory firm Schaeffer’s Investment Research conducting research on options, markets and behavioral metrics, as well as managing proprietary options-based investment strategies. He joined investment advisory firm Fund Evaluation Group (FEG) in 1999, and began researching traditional and hedge fund managers as well as conducting topical research on markets and the economy. As FEG’s chief investment strategist, Michael served as a thought leader and frequent presenter on markets and the economy. Michael is the author of countless papers as well as two books: Mission Possible, Achieving Outperformance in a Low-Return World, which was published by Dearborn Trade in 2005; and his new book, Success in a Low-Return World was published by Palgrave Macmillan in November 2018. Michael is a graduate of the University of Cincinnati with a BBA in finance, a CFA charterholder, and a CAIA charterholder.   “Now I’m thinking this is the worst possible case scenario. And it really ended up being a terrible situation because everything that I had put into the portfolio that I thought was a terrific long term investment turned out to be absolute garbage.” Michael Oyster     Support our sponsor   Today’s episode is sponsored by the Women Building Wealth membership group, the complete proven step-by-step course to guide women from novice to competent investor. To learn more, visit: WomenBuildingWealth.net.       Worst investment ever Portfolio chief has final say on what goes into investment packages In the middle of 2014, Michael was head of the portfolio management team at FEG, a very good group of talented people who advise institutional investors, and non-profit institutions, which are mostly endowments, foundations. His job at the time was to build portfolios for the clients that gave us discretion. Within a range of asset allocation targets, he and his team could build portfolios out of whatever investment ideas they thought were going to make the best return on investment with the least amount of risk. He was the primary investment person, part of a team, but he ultimately was responsible for the decision on what was the best for the portfolio. Based on firm’s philosophy, portfolio is diversified well His firm believed: it should take a very long-term approach with investing; valuation criteria should drive investment decision, that portfolios should be built out of cheap investments, not expensive; and, in the importance of diversification in portfolio construction as it is a good risk mitigator that opens opportunities to other areas of the investment world that you might not otherwise consider. Philosophically, that is where Michael and his team were starting. At the time, his investment choices were diversified into such directions as domestic equities, international equities, emerging markets, many types of fixed income, commodities, master limited partnerships, and real estate investment trusts/ Expected win with big weight in cheap emerging market stocks Michael was satisfied. They had a large allocation to emerging markets, because in mid-2014, emerging markets stocks, relative to US stocks in particular, were about as cheap as they had ever been. They had a triple weight relative to targets in emerging markets, so they thought when things turn upward, it will be a big score and they will make a killing. Suddenly, with US oil flooding global markets, the price collapses But then in the second half of 2014, something terrible happened for Michael’s portfolios. It was the beginning of the United States’ flooding of international oil markets with increasingly more capacity, and the start of the realization of what US fracking was doing to unlock the massive amount of supply coming out of the country. So the oil price collapsed. The price of oil is inversely correlated to the US dollar, meaning that the dollar rose strongly in value. Commodities, emerging markets in portfolio make for triple blow So now he has two facts working against him. He has commodities in his portfolio (for diversification) and they are being crushed as the price of oil is collapsing. All the while, the dollar is strengthening, meaning all his emerging markets and other international investments are affected as in the value of currency in those offshore spaces is weakening rapidly, inevitably damaging his investments. Emerging market currencies were collapsing, because they were working inversely relative to the dollar. At the same time, China’s economic growth, which had been skyrocketing for years, was slowing a lot faster than people had expected. So you had emerging markets, currencies collapsing and China’s weakness putting even further downward pressure on their own currency, plus those of all of the emerging market countries that sold products and raw materials to China were not growing as much. Every investment class expected to be great in long term was ‘garbage’ It was the worst possible case scenario and it put him in a terrible position because everything that he had put in the portfolio that he thought would be a winning terrific long-term investment turned out to be absolute garbage for many years. He and his firm lost clients due to this bad performance and it was a situation that took a long time to recover from. He and his team were building portfolios based on what they had established as a long-term, fundamentally strong investment philosophy, but it was completely wrong. When clients leave as a result of bad decisions on his part, he said, it is extremely painful.     Some lessons Make sure you know where the next dividend is if you’re going to short a stock Currency risk can have a dramatic impact on your investment This is especially true if an investor has an excessive allocation or an overweight situation to portfolio contents that have a high degree of concentration of that risk. “I had a high degree of concentration of risk in currency, which I didn’t really fully appreciate at the time.” Don’t expect that over the long term currency will wash itself out, you may not have the long term. Risk is not always a linear trade off of more return/more risk Investors can take risk in excess of what is justifiable based on an unexpected return. Currency is a very real risk that does not exhibit a commensurate amount of expected return. Consider diversification even away from fundamentally sound targets This is because ordinary diversification tactics may not work all the time. Do research and understand momentum Avoid limiting research to whether asset categories are expensive or cheap. Go beyond and look at their momentum and fine-tune your asset allocation based on how they are performing....