Listen to the 10th Man 

Kristina Hooper 

The Upshot 

10/7/2013 

There's no shortage of short-term risks in today's market or conventional wisdom on how they will play out. But prepping for the unexpected could limit the number of surprises and better insulate investors' portfolios, writes Kristina Hooper.
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Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

When it comes to investing, we all have our blind spots. And amid market noise, we often hear what we want to hear, filtering out the rest. But there’s a way to overcome our dulled senses so that we can spot the biggest risks to our portfolios before they strike.

Among Israeli leaders, there’s reportedly a governing principle known as the 10th Man Rule. It’s a policy that’s designed to counter the negative effects of “group think” and help government officials prepare for a worst-case scenario. The rule simply states that any major decision should be put before a panel of 10 people; when nine panelists agree on a particular outcome, it’s the 10th person’s obligation to dissent—and to plan for what will happen if that unlikely outcome is realized.

Against the Grain

The 10th Man Rule is a great concept to apply to investing for the same reason: it helps offset a herd mentality and plan for a “black swan” event. This approach to decision-making would have been helpful recently. True to his purpose, the 10th man would have disagreed with most economists by arguing that the Fed would not taper in September. And the 10th man would have dissented with the majority of investors who expected Congress to reach an eleventh-hour deal before the government shutdown on Oct. 1.

Similarly, while many investors expect the government shutdown to be short-lived and that the debt-ceiling issue will be resolved before we run out of time, the 10th man would expect a longer, messier shutdown and debt-ceiling fight. The 10th man would also prepare for greater volatility and some short-term losses among risk assets, especially stocks. Investors have been largely indifferent on the government crisis so far, especially as the debt-ceiling deadline draws near, but the 10th man would anticipate far more negative sentiment.

Unfortunately, many investors seem to get hung up on the headlines—Fed taper talk, the debt limit and the upcoming earnings season—and what they mean for stocks and core fixed income in the short run. Right now, the postponement of tapering and fears over lackluster earnings are driving investors out of stock funds and into bond funds and cash.

Loss of Confidence

However, the 10th man would be taking a step back and focusing on the monetary policy environment, which is arguably the biggest driver of relative real returns over the long run. And an important message that bears repeating is that we’re in an environment of extreme financial repression. The Fed is keeping its target interest rate near zero, which punishes savers for their discipline. At the same time, central bankers are purchasing a Costco-like quantity of government bonds and mortgage-backed securities every month to keep bond yields and mortgage rates down. That makes stocks and other risk assets more attractive than Treasuries and core bonds.

Confidence Killer

While most investors would expect the Fed to begin paring its bond purchases soon, what’s transpired in Washington since the last FOMC meeting may put tapering on hold. The government shutdown is already shattering consumer confidence: Gallup's economic confidence index's three-day rolling average stands at -34 for Oct. 1-3, down 14 points from Sept. 27-29, and its lowest average since December 2011. Meanwhile, the shutdown is delaying the release of key economic data such as the employment report, which the Fed relies on to guide its taper timeline.

Still, current monetary policy trumps all the risks most investors are focused on right now because it has a greater impact on long-term investing decisions. That’s why investors need to look at the bigger picture. Financial repression favors asset classes that are poised to offer sufficient yield and outrun inflation, such as dividend-paying stocks and high-yield bonds, despite the litany of short-term threats.

Without question, it’s hard to know what will happen from one day to the next. But the 10th Man Rule can be a useful tool in preparing investors tactically for unlikely tail-risk events. Perhaps where it could play its most meaningful role is in strategic asset allocation. The 10th Man Rule forces us to resist the herd mentality and consider evidence that doesn’t support our own views. That type of devil’s advocate perspective can help investors stay grounded and discern what’s truly important when pursuing their financial goals. In effect, it proves that one man—specifically one investor—can make a difference.

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Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

Allianz Global Investors Distributors LLC, 1633 Broadway, New York NY, 10019-7585, us.allianzgi.com, 1-800-926-4456.

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