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strategic risk 


L
ike all fund managers, TSP administration's website provides a list of risk assumed with each fund.  Inflation Risk is under all of them.  Currency risk is included only in the International Fund and Credit Risk is assumed under the Fixed Income Fund.  Market Risk is under all of them except the G Fund (money market funds).  Market Risk is a convenient way of capturing all the risks to the equity markets as a whole.  This of course is the financial industry's standardized list of risk, but in my opinion the list is actually a list of effects from the real "risks".  Another way of looking at risk, is to look at the strategic environments that effect the economy, the markets and your investments. The true risk should look more like:

 

   Monetary Policy Risk (now spilling over into Fiscal policy)

   Political-Fiscal Policy Risk (or lack of sound policy)

   International Political Stability Risk

   Financial Stability Risk

   Black Swan Risk

 

Most people would not argue that the state of the economy impacts the performance of the markets and much time is spent in "crunching the numbers" and presenting this to retail investors.  But economies are not stand alone systems to be studied and considered in isolation.  In the late 19th century those studying the "economy" wanted to be seen as engaging in a "science" and replaced the term political economy with the term economics.  The number crunching began.   The political element, so crucial to what actually happens to the economy, was obscured from economy 101 to the financial news.  And maybe this is how Wall Street wants it, investors getting lost in a sea of numbers so the market can swing from over-bought to over-sold more easily and greater profits can be taken...for wall street.   

 

My list of risk falls directly on the political side of the equation.  Others are indirectly impacted by the political side.  The only strategic risk I can think of not impacted by the political, would be a large scale natural disaster that has either a significant long-term economic impact or  a short term catastrophic financial impact not mitigated politically.  This same catastrophic "Black Swan Risk" would still be mitigated by a seasonal strategy if it occurred during the weak season (if not in equities).  So this risk might be mitigated by the reduced market exposure of seasonal strategies.  Although there are times the market is more vulnerable to larger drops or crashes and a study of valuations and over-bought situations in the context of the seasons is important to investor allocation exposure levels.

 

The effects upon the economy from these strategic risks can include inflation, runaway inflation, deflation, rapid currency revaluation, too-large-to-fail failure, bank illiquidity, customer funds missing, etc.  The effects on the market include excessive over-valuation, crashes, deep corrections, closed markets,  credit crisis,  and volatility. We have seen many of these in the last fifteen years.  They still exist and understanding the impact on the TSP funds is part of making a risk-adjusted allocation decision.  While no investment strategy can mitigate all the risk, we have to manage our investment vehicles the best we can.  History has shown that most of the fall out from these risks and others occurs during the market's seasonally weak time frame.  Again, this is not to say the market does not fall during the strong season, it does, but the bulk of the drawdown has historically occurred during the weak season. 

 

We currently shy away from investments in the F Fund due to the extreme monetary policies at present and the belief that interest rates can not go much lower, but can go much higher.  A reversion to interest rate mean will have devastating results on the F Fund.  So how do we reduce risk in a TSP account.  Currently the only option is the G Fund and in our opinion, it is a good option.   We do not have to make all or nothing allocations based upon our emotions at the time, but we should vary our exposure outside the G Fund based on some analysis of risk.  While the seasonal perspective will not shield one from all the losses, it has done a remarkable job of shielding investors from most of the large drawdowns effects on portfolios and gives one a great investment plan from which to deviate if desired.

                                         

One final note on risk, the use of the G Fund during debt ceiling brinksmanship is not a risk to your capital, the funds remain under your name at all times.  At some point in the future, Congress may decide not to make up the lost interest, but presently this does not mount to much.  If the US dollar was not the world reserve currency, then you would have something to worry about since other countries have "assumed management" of their workers pensions to meet current liquidity needs.  We live in a country that is creating a trillion dollars a year out of thin air to transfer the damaged assets (debt) of the largest banks onto the Federal Reserves balance sheet.  The need to confiscate funds in the US does not exist with this monetary tool and would be detrimental to the economy and political suicide.  A more likely scenario is after another significant bear market, for some politicians to purpose retirement funds be "guaranteed" by "investing" in "risk-free" government debt with future annuity payments.  This arrangement while financing the government would lead to other risks to be considered when we have to cross that bridge. 

 

             

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