Nadine Terman is the CEO and CIO of Solstein Capital, a wealth management and financial services firm. In the following article, Nadine Terman of Solstein Capital discusses how to balance risk to drive returns for clients.
In investing, knowing how to balance financial risks is just as important as knowing how to generate returns—especially across market cycles.
Essentially, Nadine Terman explains the tradeoff between taking risks and generating returns, and deciding to shift tactically between the two, depending on the macro and economic cycle. Given the recent global banking crisis, Nadine Terman’s insights are timely for all levels of investor sophistication. She reminds investors that is always best to make an informed decision and act based on knowledge and process, rather than intimidation, fear or uncertainty.
Taking Stock of the Current Banking Crisis
Nadine Terman recommends that investors take stock of the current banking crisis and focus on knowledge and process, versus emotions. When markets are volatile, it is easy for investors to make decisions based on crowd mentality and emotions, versus sticking with the best approach, which is to focus on knowledge and a sound investment process. To note, Nadine Terman recommends that the best investment processes incorporate an investment framework that covers various asset classes and integrates macroeconomic data.
In 2022, it was important to realize that central banks around the world were raising rates to fight high inflation. So, the value of what typically are considered long duration assets, such as long-term bonds and information technology, declined meaningfully. This is because when investors apply a higher discount rate to values far in the future, the present value of those values go down more meaningfully that assets with a shorter time horizon. So, portfolios with shorter duration assets faired better than those with longer duration assets.
Now in 2023, investors are reminded the macroeconomic data and factors like interest rates continue to be important. Various banks are in crisis mode because they purchased long-term assets, which as previously mentioned, declined in value. So, when depositors asked to withdraw their money, the banks had to sell the assets and take a permanent loss to give the depositors their funds. Unfortunately, because the banks could not hold the assets until their maturity, they ended up having to pay out more funds today than the value of their assets were worth today. Individuals and companies with assets in Silicon Valley Bank, Signature Bank, First Republic, Credit Suisse, and many regional banks have been concerned about the safety of their deposits.
Thus, Nadine Terman of Solstein Capital warns that investors must take into consideration macro data in their investment decisions, as they cannot rely on larger institutions to always do so on their behalf. If the risk management functions of these banks had been evaluating the fast move in interest rates, the type and quality of their deposit base, and the potential effects on their assets, they could have made different decisions a year ago which would have put them in a much safer position today.
UBS Takeover of Credit Suisse
Nadine Terman explains that investors cannot remain complacent after the US government stepped in to assure depositors at banks such as Silicon Valley Bank that their deposits would be safe. We are in a challenging global environment whereby governments are stepping in to stabilize not only local markets but global markets with unknown consequences.
For example, the Swiss government agreed to change its laws so that Switzerland’s biggest bank, UBS, could buy rival Credit Suisse in an emergency rescue deal that would not require the approval of shareholders. UBS is expected to offer $3.25 bn for the company, roughly 60% less than the bank was worth when markets closed before the weekend. The transaction would effectively wipe out value of shareholders without their vote. UBS and Credit Suisse rank among the 30 most important banks in the global financial system, and combined they oversee roughly $1.7 trn in assets. With such a dramatic move, there could be unknown consequences to attracting future investors who may be concerned about the rule of law and their rights as shareholders.
Nadine Terman of Solstein Capital cautions that on one hand, the move should ease near-term fears over greater financial industry contagion from the failure of Credit Suisse, on the other hand, it could dampen overall investments given uncertainty around regulations, laws and rights.
Focusing on Process and Risk Management
In many ways, risk management is equally important to generating returns. When investors limit losses on investments consistently, they have to take fewer risks in order to generate overall returns. Nadine Terman explains that essentially, there are fewer holes to fill.
Nadine Terman of Solstein Capital identifies that risk refers to the possibility of losing money or not achieving the expected profits on an asset. Various factors can contribute to this, including market volatility, economic uncertainty, recession, and business-specific factors such as management changes, buyouts, or unstable financials. Returns refer to the earned profits from an investment over a given period of time.
By maintaining a strong investment process that considers various risks of each investment as well as risks of the overall portfolio of investments, investors can avoid the temptation to take too much risk and potentially suffer additional, large losses. A strong investment process enables investors to manage risks and losses to lower levels, so that they can generate future returns for the consolidated portfolio with more managed risk-taking.
Expect Risk, But Do Not Fear It
Nadine Terman says that the following goes hand-in-hand with any strategy – expect risk, but don’t fear it.
What’s important to remember is, no matter what, risk will always be a factor in investing. However, those who take calculated chances, do their research, consider all factors, and make informed decisions based on their goals, risk tolerance, and timeline will be more successful in building wealth.
Individuals should understand that not every investment will generate a profit, and that they should be willing to take risks in pursuit of their financial objectives. If an investor lets fear affect decision-making, there is a considerable chance that they will never see a high return.
On the other hand, those who fear the potential losses may avoid investing altogether, missing out on profitable opportunities. Nadine Terman of Solstein Capital says that the key is to strike a balance between taking calculated risks and diversifying assets to decrease the potential for losses and maximize potential gains over the long-term.
Investing in the market will always come with risks – some greater than others. However, it is important to remember that investors should focus on a strong investment process that is data-driven, versus emotions.
Ultimately, while capitalizing on investments can be a powerful tool for creating wealth, it is important to remember that there are no guarantees, and investors should always approach the market with a calculated plan.