Defense wins championships.

Markets will rise and fall. Individual investments will work—and sometimes they won’t.

Risk cannot be eliminated from investing, nor should it be. Without accepting some degree of risk, investors may struggle to generate the growth necessary to keep pace with inflation and support a retirement that could last decades.

• The objective, in our view, is not to avoid risk.
• It’s to take risk deliberately—and manage it when an investment isn’t behaving as expected.

Investing in a Changing Market

Markets have changed considerably over the course of our careers.

The extraordinary growth of passive investing, index funds, ETFs, and systematic strategies has altered the way capital moves through financial markets. Every day, enormous amounts of money flow automatically into investment vehicles based not necessarily on an individual company’s valuation, but on its inclusion and weighting within an index or strategy.

• Money comes in. Securities are bought.
• Money goes out. Securities are sold.

That matters more than what may appear obvious on the surface.

There may be times when an investment appears expensive by traditional valuation measures and continues to appreciate as capital continues flowing into it. Valuation remains important, but we don’t believe valuation alone is sufficient to determine when an investment should be owned—or when it should be sold.

Markets can remain expensive far longer than investors expect.

The greater concern often emerges when the direction of those flows changes.

Markets historically tend to decline much faster than they rise. What may have taken months or years to build can sometimes be lost in weeks — or even days.

That’s one reason our investment process has evolved with the markets themselves.

Rather than relying on any single measure, our models consider the interaction of price, volume, and volatility as part of our risk-management discipline.

• Price tells us what the market is actually doing.
• Volume can provide insight into the conviction behind those movements.
• Volatility helps us understand the magnitude of risk we’re accepting.

Together, they help us evaluate when risk may be changing—and when protecting capital may become more important than pursuing additional return.

Why Downside Matters

The mathematics of loss are asymmetric.

The deeper the decline, the greater the return required simply to get back to where you started.

For retirees taking distributions, the consequences can be greater still.

When portfolio values decline while withdrawals continue, those distributions permanently remove capital that would otherwise remain available to participate in a subsequent recovery.

That’s sequence-of-return risk—and it’s one of the reasons we believe managing downside becomes increasingly important as a portfolio transitions from accumulating wealth to providing retirement income.

But downside management isn’t only about avoiding loss.

It’s also about preserving the capital available to compound when opportunity returns.

Capital that isn’t lost doesn’t have to be recovered before it can begin growing again.

That’s why we don’t view downside management and long-term compounding as opposing objectives.

Downside management is part of the compounding process.

Cut Losses. Let Winners Run.

One of the most important lessons we’ve learned over decades of investing is also one of the simplest:

Not every investment will work.

We don’t believe successful investing requires pretending otherwise.

Before making an investment, we seek to understand both its opportunity and its downside. Once invested, price, volume, and volatility help us continually evaluate whether the risk we’re taking remains justified.

If an investment is working, we want to give it the opportunity to continue working — even when traditional measures suggest it may have become expensive.

When we’re right, we believe in allowing winners room to run.

When the evidence changes, however, so should our willingness to own the investment.

Rather than allowing a losing position to become an increasingly significant drag on a portfolio, our discipline is designed to identify deteriorating investments and reduce or eliminate those exposures before manageable losses have the opportunity to become materially larger ones.

That doesn’t mean every investment we sell will continue lower.

And it doesn’t mean every investment we retain will continue higher.

It means we would rather remain disciplined than allow the hope of being right tomorrow to become the reason we ignore risk today.

Capital Preservation Doesn’t Mean Avoiding Opportunity

Coach Bryant understood that offense and defense aren’t opposing objectives — a team needs both.

We believe investing is much the same.

Growth matters. Returns matter. A retirement portfolio may need to provide income for decades while keeping pace with the rising cost of living.

Capital preservation therefore doesn’t mean sitting on the sidelines waiting for the next market decline.

Nor does it mean refusing to own an investment simply because traditional valuation measures suggest it has become expensive.

It means participating in opportunity while maintaining the discipline to defend capital when the evidence changes.

That distinction has become increasingly important as financial markets themselves have evolved.

Not every financial risk should be solved inside the investment portfolio. The financial plan determines which assets belong in the markets.

Our Investment Approach determines how we manage the capital that does.

How Our Models Are Managed

Within the portion of a financial plan entrusted to the markets, our discretionary investment models are managed from a client-first perspective.

We believe every position in a portfolio should have a purpose, and every risk taken should be understood in the context of the broader plan.

Position sizes are informed in part by the historical volatility of the underlying investment. Rather than assuming every investment represents the same degree of risk simply because the same number of dollars is invested, we consider the volatility and downside characteristics of each position when determining its appropriate size within a portfolio.

From there, price, volume, and volatility remain important components of our ongoing risk-management process.

We aren’t trying to identify the exact top of every winner or the exact bottom of every loser.

We don’t believe anyone can consistently do that.

Instead, we’re looking for evidence:

• Is price confirming our thesis?
• Is participation strengthening or deteriorating?
• Is volatility changing the risk profile of the position?
• Has the relationship between potential reward and downside risk changed enough to warrant action?

Winning investments are given room to work.

Losing investments are evaluated with discipline rather than emotion.

And when the evidence tells us the risk of continuing to hold an investment is no longer justified by its potential reward, we’re willing to act.

All investors participating in the same model receive the same execution price, regardless of the amount of capital they have invested.

We won’t avoid every decline.

We won’t identify every market top or bottom.

And we won’t get every investment right.

No investment manager will.

What we can control is the discipline with which we respond.

• Understand the risk.
• Size it appropriately.
• Respect what the market is telling us.
• Cut losses when necessary.
• Give winners the opportunity to run.

The objective is to participate when opportunity is present while maintaining the discipline to protect capital when the evidence changes.

That is what defense means to us.

All investing involves risk, including the possible loss of principal. Diversification, asset allocation, asset location, and risk-management strategies do not assure a profit or protect against loss in a declining market. There is no assurance that any investment process or risk-management discipline will achieve its objective or prevent losses in a declining market. Past performance is not indicative of future results. Other Side Asset Management does not provide legal or tax advice.