Portfolio Risks; Look at Investor Bases: Best of Kass

In highlights from this week's trading diary and posts, Kass discusses the amount of risk many retail investors have and also discusses how to look at the four most important bases.

By Doug Kass , Sep 22, 2017 9:00 PM EDT

Top thoughts on stocks and the markets from TheStreet's Doug Kass.

Many Retail Investors Have More Risk in Their Portfolios Than They Presume

Originally published Sept. 21 at 1:06 p.m. EDT

Here is some more food for thought -- this is an issue I have not read about yet, but I think we will ahead.

One day stocks will move lower, perhaps much lower.

Once stocks ARE down 20%, many investors will start to freak out, especially if we don't bounce immediately. This is particularly true of many RIA (Registered Investment Advisor) clients who are older -- which is the case of many!

However, it may be that the biggest risk at that time will be in bond portfolios, not stocks, particularly corporate bonds given the massive flows.

Let me explain.

Everyone talks about all the money that's gone into bonds, and everyone is bearish on bonds. But if you say to them, "Wow, you think corporate bonds are a sale??" they will likely reply, "No, not corporates, Treasury bonds are a sell."

But here's the thing -- 80% of all of the inflows in the last few years have gone to corporate/HY (high yield) bonds.

So when you look at portfolios, and this is a guess, but I'll bet that a 60% equity /40% bond mix in 2000 was broken down into 20% treasuries, 12% investment grade, 8% HY. Today, the same 40% committed to bonds is now about 8% treasuries, 12% investment grade and 20%HY!!

Most investors don't get that a bear market takes HY down almost as much as stocks. So they're 60%/40% mix of stocks to bonds, might realistically behave more like a risky 75% in equities and 25% bonds -- causing more pain in any further decline in he capital markets!

Position: none.

A Basic Look at the Investor Bases

Originally published Sept. 21 at 9:57 a.m. EDT

In my opening missive I suggest that a meaningful reason for the buy-the-dip philosophy has to do with the increased role of passive investing and quant strategies that are governed by pre-set algorithms.

Let's do a deeper dive into highlighting the composition and motivation of the four most important investor bases today that have influenced dip buying:

Mutual funds that only are seeing outflows but must run fully invested, so they have a limited impact on the markets.

Hedge funds that have a low level of net exposure, can't take any risks at this point, and must hedge on every selloff but cover when it rolls up. So, all they really do is create intraday volatility.

Registered Investment Advisors (RIAs), the group that really matters because they now control all of the money. You could substitute endowments or pensions in there, too. But basically, this bucket is fully invested in indices, and they are using the prior 10-year return numbers as justification versus active management. They believe they are "in it for the long term,"so they don't get rattled when the market dips slightly because they know that eventually will happen, but every selloff goes to new highs within a couple years (see 2008, 2011, 2015-16), so why would you ever sell??!!!

Quants/algorithms/HFTs (high-frequency trading), a bucket that by far is the smallest but has the most power because they can trade all day every day. The smaller quants/algos go home flat every night, so they take no news risk and thus have plenty of capital to buy the dip. And because they are programmed to do it, they will do it every time until it stops working. But because they are the only money moving around, and with billions of dollars a day to put to work, they can overwhelm any of the sellers.

Position: None.

Doug Kass fills his blog on RealMoney every day with his up-to-the-minute reactions to what's happening in the market and his legendary ahead-of-the-crowd ideas. This week he blogged on: