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You can’t spell volatile without “L” “I” “E”

Articles | 28 February 2018

If “they” are right, then there is virtually never a bad time to be fully invested. 

The term "volatility” has become a euphemism. What people mean when they say, “markets have experienced some volatility” is that markets have gone down. You never hear a financial commentator bang on about those pesky volatile stocks that are up every single day and breaking new highs. Being the “bearer of bad news” or not wanting to “shoot the messenger” reflect just how badly most people feel when disappointing others. Investors in particular have a hard time honestly discussing bad news. This is not surprising and deeply imbedded in human nature. People don’t like focusing on the negatives either through blind optimism or delusion. Most people lie to themselves, especially when it comes to money.

When the property market goes down, it’s a “buyer’s market.” When bonds deliver negative returns, yields have gone up! When stocks sell off, it’s a buying opportunity because they’ve gone “on sale.” Even when acknowledging things are bad, you “buy the dip” or are glad that the market has finally “capitulated” which is a signal to “get back in.” Assets don’t fall but rather “reprice.” If you liked it at $10, you’ll love it at $5.

Fundamentals are still good they say! Investors have lots of cash on the sidelines to hoover up those cheap assets they say! It’s not “timing the market” but “time in the market” they say!   

But what if “they” are wrong and it’s all a bit of self-deception to take the sting out of the negative news?
If they are right, then there is virtually never a bad time to be fully invested. This makes sense from a multi-asset perspective as higher risk, higher return assets tend outperform over time. And this also makes sense given many investors focus on a single asset class. In fact, professional fund managers often are required to be more-or-less fully invested in their particular asset class. Have you ever met a high yield analyst who didn’t like high yield? Or a small caps equity manager who didn’t like small cap equities? This is often because there is almost always compelling relative value offered in any particular area of the market, and it takes a much broader perspective to see that an entire asset class may be overvalued. Equities have gone up 2/3 of the time over the past 50 years. It’s a positive expected value (+EV) trade to be long. Why not just “ride the volatility”, “fill your boots”, and “stay the course”?

These behavioural biases are precisely why a multi-asset approach has distinct advantages, particularly when the freedom exists to move considerably both within and across asset classes.

This “volatile” environment hasn’t surprised us – but no fund manager has an asset allocation crystal ball. Should we have held more equities in our real return strategy to start the year (we had the lowest allocation since the 5-year start of the fund in Dec 2012)? Maybe we should have held more credit in January (we cut our high yield exposure in December after a remarkable run)? We require some grounding in medium- to long-term expected returns, and valuations play an important role. And our analysis of the fundamentals point to lower expected returns in the period ahead. It’s not ideal when trying to deliver CPI+ 4-5% but at least we’re being honest with ourselves. This doesn’t mean more equities – but often less. To deliver on objectives, it also means more dynamic asset allocation shifts and protection strategies. This means we rely more on our own investment skill (alpha) rather than markets (beta) to hit objectives in the period ahead. Challenging? Yes, but at least we can sleep at night with a clear conscience (assuming we don’t have too many more volatile periods like this).

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