Everyone Should be a Risk-Averse Investor

07/21/2011 2:30 pm EST


Ken Kam

CEO, Marketocracy, Inc.

After watching the market crash twice in ten years, people need to protect themselves going forward. In an exclusive interview with MoneyShow.com, Ken Kam of Marketocracy explains two simple ways to reduce your risk.

Ken, what do you tell the risk-averse investor?

That’s a great question. I think all investors are risk-averse, and they should be after watching the market crash twice in the last ten years by 50%. I think if you’re not prepared for another such crash in the next ten years, that you don’t really have a financial plan.

Now out of the money you have in the market, if you were to tell me that if you lost 50% of that it would devastate you, then I’d tell you that you have too much invested in the market. You need to find a product—it could still be invested in the market—but you need to find a strategy, and you need to find people who have a good track record of knowing when to get out of the market.

How do you find that?

Well, that is an extremely rare thing. They don’t keep records of this. Morningstar doesn’t track this. But I’ve been tracking this at Marketocracy.

I’ve been able to find people who have been able to outperform the market by enough to make a difference, but who over the long run have had half the maximum drawdown of the market—so while the market has fallen 50%, these people have fallen 25%. Still, you have to put some money at risk, but these are the kind of people that I think a risk-averse investor should be looking for.

What types of strategies do these managers use that can outperform, get better returns with less risk?

Well, there are two principal ones. The first one is very simple to understand: it is to sell.

I mean, most prospectuses for mutual funds and all ETFs require them to be nearly fully invested all the time. Even when the market looks volatile and risky, and nobody is comfortable, it’s got to be 100% invested.

Well the simple thing to do is to sell, and the person you want to make that judgment is the portfolio manager. Giving the portfolio manager, with a great track record, the latitude to sell is the first tool, but then it's selling at the right time. You can only tell that from their track record.

The second tool is these new inverse-market ETFs. Right now these are a little dangerous. If you hold on to them too long, they can blow up in your hand. I like to think of them like hand grenades, but in the right hands they can be used to reduce your market exposure by a great deal, a great amount with just a small transaction.

In the right hands it can be a very good tool to reduce the risk of your overall portfolio at the right times.

Those two, so you know when to sell.

Yes, finding people who have a good track record of knowing when to sell—and whose prospectus allows them to do that—and finding people who have a great track record of using these inverse-market ETFs to not just sell but take down the market exposure at the right times.

And that’s saying when you buy one of these inverse-market ETFs, when the market goes down, it goes up.

Yes, that’s so it gives you a nice buffer, and that’s how you can protect on the downside but still be invested, so if the market continues to go up, hopefully, you’ll still do well.

Is there any ETF that you’re looking at right now that will do that?

Well actually, there's one that is the biggest position that we have—and even when I say that, it’s still not a big position. It’s an inverse gold ETN, the DB Gold Double Short ETN (DZZ).

The person who picked that tells me that the price of gold is way above the production costs of gold by any historical standards. As the level of fear in the world decapitates, the price of gold should come down.

When you’re trying to take market exposure out of your portfolio, you don’t want to take it across the board...you want to take market exposure off in the part of the market that you think is the most overvalued. In this person’s judgment, it’s gold.

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