In my view, the necessary objective is to
accept market risk when the likely return / risk profile is attractive, based on observable measures of valuation and market action, and to avoid, hedge, or diversify away those risks that don't carry attractive return / risk profiles on average.
Even if we observe rich valuations, there can be some justification
for accepting market risk during periods when market internals are uniformly strong, provided that the environment is not also characterized by a syndrome of overbought, overbullish and rising - interest rate conditions.
Once valuations are rich and our broad return / risk estimates are negative, our willingness to
accept market risk generally requires a window with two exits — one below, at the point where the trend - following measures deteriorate, and one above, at the point where overvalued, overbought, overbullish conditions emerge.
The chance of an index fund outperforming one of your star managers (after costs) in any given year is quite high, because most investment returns come from
simply accepting market risks (beta), which requires no skill.
This is, after all, still an environment in which we've been willing to
accept market risk.
At present, the evidence indicates that it is appropriate to
accept market risk, but with something of a «stop» in the form of put option coverage close to (or a few percent below) current levels.
Even so, we lifted about 70 % of our hedges in early 2003, so it should not be assumed that we require historically normal valuations in order to
accept market risk.
That objective is to
accept market risk in conditions that have generally been associated with high or at least acceptable average return / risk tradeoffs, and to avoid or hedge away market risk in conditions that have generally produced hostile tradeoffs, on average.
Variable universal life insurance combines the core benefit of life insurance — protection for beneficiaries through an income - tax free death benefit — with significant flexibility for those willing to
accept market risk.