The author of this piece sets out five steps for investors navigating volatile markets.
While market volatility isn’t necessarily the same issue as risk – a common misperception – the increased choppiness of markets undeniably makes investors nervous and can also make it more difficult to get a true handle on what is happening to portfolios. One widely-cited measure of equity market volatility is the VIX Index, which tracks option market prices in the US stock market. (The higher the index level, the more volatile markets are, and vice versa.) The index is currently around 18 and it spiked in the summer of last year to over 40 at the time of the massive sell-offs to mainland Chinese equities, which also hit global equity sentiment. Falls to oil prices, and subsequent rises in gold prices, have also added to a picture of volatile markets.
In the following article, Guy Huntrods, managing director and head of investment counsellors for RBC Wealth Management, examines the actions investors can take when markets are as volatile as now. As always, the editors here welcome this contribution to debate and invite readers to respond.
Since the start of the year, we have witnessed market volatility spike to levels that would give any investor pause for concern. The correction that began last summer went into hibernation for a short period, but the markets have again reminded us of the tough road towards stability and normalisation.
Equity markets worldwide remain under pressure driven by collective worries over weakness in China, persistently low oil prices and fears of a global slowdown. Uncertainty around the pattern of future central bank interest rate activity sets the stage for continued uncertainty in the overall economy, and the financial sector in particular.
Investors are very much aware of the sustained and unresolved geopolitical issues spanning every continent. Volatility, as we’ve seen, is not uncommon against such a backdrop of events. However, while this bumpy road may have some months left to run, the secular bull market that began in 2009 is likely to continue driving mild but sustainable global growth.
So what should investors be thinking about in the short to medium term to ensure that their portfolios can ride out the current storm?
The importance of discipline and diversification in a portfolio is highlighted by current market conditions. As investors review their portfolios, it is important to contemplate their circumstances and whether rebalancing investments may be appropriate. This is an essential element of monitoring the integrity of portfolio strategy that should be undertaken regularly in order to keep investment objectives on track.
Most portfolios will have firstly a strategic asset allocation which represents a core blend between major asset classes, and offers the optimal combination of risk versus potential return, with a focus on long-term investment objectives. This should reduce volatility and minimise drawdown in such a market environment.
Secondly, there will be a tactical element which involves determining if any short-term allocation tilts or opportunistic investment ideas are appropriate to complement to the portfolio’s core asset allocation. Whether the strategy is anchored around a core allocation, or when tactical components are included, above all, investors should take care to regularly review their investments. If one’s aim is to "buy and hold", it should never become "buy and forget".
Of course, portfolios with too heavy a weighting in either equities or fixed income are left open to undue risk, but so too are those with oversized cash reserves. During market turmoil, it can be useful to reflect on historical data, notwithstanding that it is not an indication of future performance. Indeed, successfully timing the markets consistently is very difficult, if not impossible, but staying invested throughout various market conditions and opportunistically adding cash "on the dips" of an otherwise fundamentally recovering market has its benefits.
Generally speaking, those who stayed invested in an asset allocated portfolio during the recent period have been able to generate attractive returns. And as long as a portfolio remains diversified, fluctuating markets can actually provide rare opportunities for future growth – it’s not too often when strong and defensive companies go "on sale".
With that in mind, there are a few key questions that every investor needs to consider to evaluate their portfolio during the current volatile market conditions:
1. Has there been a significant allocation drift since the last portfolio review?
2. Is there a highly concentrated position present in the portfolio? Does it require hedging?
3. What is the currency exposure and is it necessary?
4. Is the equity exposure properly positioned across regions or sectors?
5. Is the fixed income exposure appropriately positioned in terms of quality and duration?
So, regardless of the approach to dealing with portfolio asset class imbalance, or oversized stock concentrations, the principle of diversification remains.
These are demanding markets, facing significant economic challenges coupled with ongoing geopolitical considerations. A skilled investment professional can provide the guidance and advice on which appropriate options are available for keeping a client’s investment strategy optimised, while uncovering opportunities that volatile markets can present from time to time.