Navigating volatile markets: persevere, diversity in stormy economy.

• Author: Kaminis, Markos N.
• Position: FINANCE

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Mariners who have ridden the rough seas of the Gulf of Alaska can easily relate to the investment climate of the last two years. At times, the waves of economic chaos have risen high enough to obscure all view of our previously stable and still colossal economic ship. The turbulence had even seasoned strategists, who were once comfortable and confident, suddenly turned introspective and insecure. Our ship captains underestimated the terror of the storm as well. Despite the darkest of clouds forming above, they promised the damage would be contained to the real estate and mortgage sectors. Before they knew it, one of the greatest crises of our generation had enveloped us all.

NO PLACE TO HIDE

In this historic downturn, new record lows have been set across economic metrics. Great legends of American industry and finance, like General Motors (NYSE: GM), Bear Stearns, Lehman Brothers, AIG (NYSE: AIG), Fannie Mae (NYSE: FNM) and Citigroup (NYSE: C) have been left reeling. There has been no place for investors to hide.

The hallowed halls of ivy-garnished academia have long held that diversification would always prove our best guard against volatility. Our 401K plans were sold to us with this promise, and we were able to sleep at night because of it. What happened in the chaos was another story. Security correlations collided at 1.0, where all investment assets move in unison. Guess in which direction they went. Corporate equities and bonds, municipal bonds, commodities and real estate all shed value in 2008.

Even beta neutral strategies, or those seeking to balance long and short trades saw diminished opportunity in a market where imbalance was overwhelmingly negative. Beta neutrality is the brainiac's extension of diversification, because to be so diversified to include bets on the downside movement of securities must be perfect diversification.

INVESTORS GREATEST ASSET

If there is one tool that is most necessary to navigate through volatile markets, it is perseverance. If diversification couldn't save us, then maybe stubborn determination will. If what goes up, must come down, then maybe what goes down (and doesn't go bankrupt) can rise again. The greatest investor of all-time, Warren Buffet, who by the way also had a lousy year in 2008 (Berkshire Hathaway's Class A Shares (NYSE: BRK-A) lost 31.8 percent of their market value, while the company shed 9.6 percent of book value), put it best. He told Berkshire Hathaway investors, "Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th century alone, we dealt with two great wars; a dozen or so panics and recessions; virulent inflation that led to a 21.5 percent prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15 percent and 25 percent for many years. America has had no shortage of challenges. Without fail, however, we've overcome them."

Buffet has had many great years captaining his ship, but...