Industry Voice: Investing in volatile times

A more volatile investment environment can prompt a sharper focus on diversification as a way to manage risk and renewed interest in different approaches to multi-asset investing and fund choices.

A resurgence in market volatility and declines in values across major asset classes in 2018, is prompting investors to question whether they ought to adopt a more low-risk investment strategy.

A slowdown in global growth and geo-political concerns including US-China trade tensions and Brexit are likely to ensure volatility remains a hot topic for investors who often worry because they associate volatility with falls in value.  However, volatility actually refers to price moves upwards or downwards, so  it presents risks and opportunities .

A measured response is vital: panic-selling can lock in losses and may mean missing out on a recovery. Likewise, switching investment approach without considering longer-term implications could make it harder to achieve investment objectives.

Investing through volatile times should not involve knee-jerk reactions.  It requires a disciplined approach to assessing and mitigating different types of risk (including volatility) to different asset classes, such as equities, government and corporate bonds, and alternative assets such as property and commodities. Expert asset allocation and portfolio management, robust governance and maintaining a long-term perspective are critical.

Concerns over volatility have been exacerbated by the fact it has rebounded from historically low levels. Research into S&P 500 volatility by US firm Adviser Investment found that long-term average standard deviation (a measure of volatility) for the S&P 500 from 1957 to 2017 was 15.6%. In 2017 it was 6.7%, the second lowest on record after 1963.

Volatility in US equity indices has a ricochet effect on global equity markets and can impact fixed income assets too, as happened last year. So although volatility is an integral part of investing, investors may struggle to adjust to more normal levels of volatility.

Increased volatility is refocusing attention on multi-asset  funds as a way to avoid placing all an investor’s  eggs in one basket. Scottish Widows has a range of independently risk-rated multi-asset funds offering a spectrum of potential returns aligned with investment objective and risk tolerance.

Multi-asset investing is not about assembling a random mix of assets and hoping some do better than others. It involves expert assessment of asset types that behave in different ways under various investment conditions, and skilfully combining them in a single fund. The aim is to reduce the impact of volatility by offsetting potential falls in one asset class with potential gains in another. Diverse asset classes rarely perform in identical ways year after year –  factors such as interest rates, inflation or world events tend to impact differently on different asset types. Data on overseas equities, UK equities, UK government bonds, UK property, commodities and cash from 2002 to 2017 show a wide variations in returns on a year-by-year basis.

Last year was unusual, as most major asset classes reported negative total returns with the exception of UK gilts, cash and UK commercial property. According to Schroders, 2018 was only the third year since 1900 that returns from the S&P 500 share index and 10-year US Treasuries were negative in the same year. 

Our multi-asset funds are not expected to produce positive returns in all short-term market conditions: broadly, investors in lower-risk-rated funds should expect lower levels of volatility but may see lower long-term growth, while those in higher-risk-rated funds should expect higher levels of short-term volatility but potential for greater long-term growth.

We concentrate on medium- and long-term asset allocations as the main determinants of multi-asset fund performance. Our in-house team is responsible for long-term asset allocation which is done on a horizon of five years plus and optimised around once a year, and medium-term asset allocation on a horizon of 18 months to five years. Tactical asset allocation, on a horizon of less than a year, is done by an external fund manager.

We ensure asset allocation strategy remains appropriate and keep asset allocation for all multi-asset funds under review. We are also alert to opportunities where an asset class may be significantly undervalued relative to its own history or other asset classes. The recent fall in UK equity valuations to historic low levels, relative to other developed equities, is an example of a short-term change that presented a longer-term investment opportunity. In the second half of 2018, we increased some of our multi-asset funds’ exposure to UK equities as we believed the discount was unjustified.

Customers already invested in multi-asset funds that meet their investment risk tolerance should not be diverted from long-term goals by short-term volatility spikes. Meanwhile, customers worried about volatility impact may wish to explore multi-asset investing as a potential way to reduce  investment risk.

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