While volatility has been increasing in the past several years, the beginning of 2017 has shown an eerie calm, with January showing the lowest market volatility since 1983. What does this mean? We know from historical data that low volatility can signal a calm before a storm and often precedes bear markets.
With markets hovering near all-time highs and volatility at record lows…
- Is your portfolio built to survive market volatility?
- Can your portfolio sustain a market correction?
- Is your Investment Committee prepared?
In the cycle of market emotions, there’s typically an ebb and flow of a market cycle: the market rises, peaks, declines, bottoms-out and then begins to rise again. In any market, the point of maximum financial risk is at the market peak, when prices are highest. The point of maximum financial opportunity is at a market bottom, when investment prices are lowest. Surprisingly, this is the exact opposite of what investors feel (and consequently how they behave) at these crucial points in every market cycle.
In fact, research shows that investors’ accounts perform much worse than the stock market when they try to time the markets. A study from DALBAR in 2015 showed that the average stock fund investor earned average annual returns of 5.19% from 1995 to 2014, while the S&P 500 earned 9.85%. Clearly, investors hurt their returns by trying to time the markets.
As we endure increased volatility and market corrections, it’s critical to help your Investment Committee avoid costly financial mistakes during downturns. Selling or making market moves driven by human emotion when the market is down can be difficult or impossible to recover from. Traditionally, diversification was the key to mitigating risk in portfolios. However, many experts think there is more to this equation now to perform in today’s markets.
Modern Portfolio Theory was developed in 1952 as a way to describe the trade off between risk and reward in investing and advocated for diversification to reduce risk. While the theory has offered critical guidance for investors over the past 60 years, it does not take into account investor behavior or the increased access to investment information we have today.
Another way to mitigate the risk of investor behavior is by accepting market volatility and addressing Investment Committee expectations and role play potential portfolio return scenarios to assist them to stay the course and weather the storm. By preparing for different scenarios well in advance, we can help to take the human emotion and element of surprise out of institutional long-term investing. To address inevitable market volatility and best help Investment Committees avoid mistakes, we recommend taking the following steps.
1. Revisit Your Investment Policy Statement
Your Investment Policy Statement (IPS) should take into account expected volatility and the importance of a long-term investment outlook. We know that in the past, bear markets occur regularly and take some time to recover. Since 1926, it has taken an average of 3.3 years for stocks to surpass their high set before the typical bear market began. Does your Investment Policy Statement acknowledge normal bear markets and encourage patience during recoveries? Does your IPS have set asset allocation ranges of which are appropriate for the Investment Committee’s risk/return appetite?
2. Rebalance if Needed
Portfolio rebalancing is a critical action if investments fall outside of allocation ranges stated in the Investment Policy Statement. With stock markets at record highs, the equity portion of a portfolio may have grown to represent a higher proportion than intended. Rebalancing accounts can help establish proper asset allocation to lower the overall risk in a portfolio.
3. Keep a Long-Term Outlook
Embracing a long-term investment horizon can help make market volatility less uncomfortable for the Committee, and being patient and staying the course is so critical. Be sure that your Investment Committee understands that market corrections are a normal and healthy part of market cycles. Understanding that temporary losses are an inevitable part of investing can assist Committees from making over-corrective decisions that can derail the long-term success of a portfolio.
In the face of a potential bear market, it’s crucial to prepare in advance to help your Investment Committee to remain committed to your strategy, achieving the organization’s long-term investment goals and mission. By reviewing your investment philosophy, ensuring portfolios are appropriately diversified, and keeping a long-term outlook, your Investment Committee is setting up your organization with the possibility of earning greater long-term returns and success.
If your Investment Committee needs assistance with establishing a plan for navigating the volatile market landscape, call our consulting team at (949) 718-1600 or email us at email@example.com. Don’t wait for a market downturn to push you into action, prepare now so the coming bear market won’t catch you by surprise.
Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.
© Beacon Pointe Advisors. All Rights Reserved.