War, oil and the markets

In the last month or so since the start of the Iran conflict markets have become significantly more volatile and major indices have been negative. Our practice's approach to wealth management is very well positioned for this environment.

Periods of market stress have a way of revealing what investors actually own versus what they thought they owned. When markets are calm and trending higher, the differences between active and passive investing, between knowing your portfolio intimately and delegating it broadly, can seem academic. When the world changes quickly — as it has in recent months — those differences become very real and very consequential.

For example, index funds or passive investing have genuinely served investors well over the past decade. In a low inflation, low-rate environment driven by technology and growth, owning everything cheaply and efficiently was a difficult strategy to beat. In times of market change, though, structural limitations of passive investing are more visible. The S&P 500 currently allocates roughly a third of its weight to technology and communication services — sectors whose valuations are mathematically sensitive to rising interest rates. It allocates only three percent to energy, a sector that has been among the strongest performers in the current environment. Nobody actively chose that mismatch. It is a mechanical artifact of market capitalization weighting that updates slowly and without judgment. When the world changes, index funds change with it — but only after the fact. The investor who owns the index owns yesterday’s consensus, priced at today’s market. In a stable environment that’s fine. In a rapidly shifting one it creates silent, structural misalignment between what a portfolio holds and what the current environment actually rewards.

There is a concept in thoughtful portfolio management that sounds straightforward but is genuinely rare in practice: knowing exactly what you own, precisely why you own it, and specifically what would cause you to change your mind. This is different from knowing your sector allocation or your asset class exposure. It means understanding the specific investment thesis behind each individual position — what conditions make it attractive, what risks could undermine it, and how it behaves relative to other holdings when the macro environment shifts. Consider two investors with energy exposure in today's environment. One owns an energy sector ETF. The other sees the current situation and elects to overweight energy. They own a carefully selected combination of an integrated oil major, a domestic natural gas exporter, a pure-play domestic producer, and an agricultural fertilizer company. Both have energy exposure. But only the second investor has a framework for understanding why each position behaves differently as conditions evolve — and therefore which to hold most firmly, which to reduce first, and how to sequence decisions intelligently as the situation changes. That kind of granular understanding is what allows a portfolio to be managed rather than merely held.

Beyond energy, your indexed portfolio likely has exposure to other things you might not want in this environment (airlines come to mind because of jet fuel) and also exposure to 2nd and 3rd tier companies in industries. Holding a transparent and concentrated portfolio of stocks allows you to control that allocation as well as hold only the top tier companies if that's what you choose.

Outsourcing investment management — whether to external managers, model portfolios, or broadly diversified funds — trades flexibility and transparency for convenience. In stable markets that trade is often worth making. In rapidly changing ones the cost becomes apparent. When the investment thesis shifts meaningfully, the investor who manages individual securities has transparency and can act quickly. The decisions may not always be right, but they are made with full transparency and understanding and can also be adjusted again as the situation dictates. When advisors working with clients use third party management that gets taken away.

Markets like these are not rewarding passive exposure to consensus positioning. They are rewarding investors who understand what they own, why they own it, and what specific conditions would change their mind. The current environment will resolve, as they always do. The investors who navigate it most successfully will those who have known what they own and why, positioned for the current environment, scenario plan for possibilities and then have the ability to quickly react to changes and take advantage of opportunities as they happen.