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Posted on DEC 14, 2017

Johnson Bank Wealth Weekly Investment Commentary | Thursday, December 14

This is part of an ongoing series of Weekly Commentary articles published by Johnson Financial Group.
This week's commentary was written by Jason Herried, Senior Vice President, Wealth Portfolio Manager.

Taking Risk Management to a Higher Level

One of the most important decisions in portfolio risk management is asset allocation, specifically the percentage of the portfolio allocated to equities since their prices are more volatile. Over the past year, we have endeavored to position portfolios near our clients' long‐term target equity allocation and take profits during this period of strong stock market performance. While this level of risk management provides some advantage, our strategy groups (equity, fixed income and complements) regularly take risk management to a higher level.

To cite a recent case, our Equity Strategy Group (ESG) wanted to review the exposure to the seemingly richly valued, high growth technology stocks that have led the equity market in 2017. Our model portfolios had been overweight to growth‐style stocks relative to value‐style stocks until taking profits after substantial outperformance of growth styles. The main driver of the growth outperformance has been the strong performance of technology stocks, specifically the FAANG stocks. FAANG is an acronym for five technology stocks in the U.S. equity markets – Facebook, Apple, Amazon, Netflix and Google (now Alphabet Inc.) – and is often reflective of the disruptive force of technology. The FAANG stocks have been a substantial driver of returns for the S&P 500 Index, contributing 27% of total gains through October 31, 2017, and over the previous three years.

FAANG Stock Growth Chart

Source: Bespoke Investment Group

The FAANG stocks and other high growth technology stocks have attracted investor attention because of rapid profit growth and the way they are disrupting established industries. Facebook is changing the way we communicate and capturing advertising dollars along the way. Online retailer Amazon has disrupted brick‐and‐mortar retail companies through competitive pricing and same‐day delivery of customer orders. Apple continues to lead the charge in mobile computing. Netflix is disrupting the traditional pay TV model, and Google continues its lead in internet search as well as dabbling in other ventures like driverless cars.

With many of the FAANG and related high growth technology stocks up over 50% year‐to‐date and with rising valuations, our ESG wanted to verify that our investment strategies were no longer overweight after repositioning from growth toward value and determine if additional action would be necessary.

For the initial analysis, the ESG asked our investment research team to conduct a top‐down analysis to stress test the portfolio to a 10% decline in the prices of the stocks in the Software & Services industry group (used as a proxy for high growth technology stocks). The conclusion was that the portfolio had modestly lower downside risk to a large decline in the Software & Services industry group as compared to the benchmark.

To confirm those findings, a secondary analysis was performed based on a bottom‐up, holdings‐based analysis. While the group wanted to verify that it wasn't overexposed to the FAANG stocks, the holdings‐based analysis revealed that the portfolio was actually underweight the FAANG stocks detailed above. The analysis also revealed that the largest exposure to high growth technology stocks was to international companies, specifically Baidu (the Google of China), Alibaba (the Amazon of China), and Tencent (a Chinese web services company). After discussing the findings, the group concluded that our model portfolios have benefited from the stock picking of our third‐party fund managers. Stated differently, our managers collectively believe the investment case for high growth technology stocks is better outside the U.S. (and in China specifically) than in the U.S.‐based FAANG stocks that dominate the headlines.

Upon conclusion of the above‐referenced risk management review, the ESG was able to confirm that our model portfolios had the desired exposure to high growth technology stocks. By implementing thorough risk management practices as part of our investment management process, our strategy groups are taking risk management to a higher level. By doing so, they are working to balance our clients' objectives with the risk taken to meet those objectives and to understand the factors that are likely to drive portfolio performance.

Jason Herried
Jason Herried, CFA
As Senior Vice President and Wealth Portfolio Manager, Jason provides asset management, financial planning, trust advisory and other financial services to clients. Jason is a member of the firm’s Investment Committee and leads the Equity Strategy Group.

This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Cleary Gull Advisors Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE


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