Investing during market volatility
How might you react to swings in stock market prices?
Volatile financial markets are an inevitable part of investing. On a day-to-day basis the swings in stock market prices can be significant; however over the longer term things have tended to smooth out with daily volatility having a lower impact on overall portfolios This said, whilst this has happened in the past it's may not necessarily happen in the future.
The key questions though for many investors are often:
- Should I hold steady?
- Should I sell?
- Should I invest?
A time to sell or hold steady?
Turbulence in asset prices can be unsettling for investors. Whenever financial markets suffer periods of heavy losses and the newspapers are full of gloomy headlines, there’s a temptation to sell parts of your portfolio and retreat to cash, or other perceived safe havens.
A diversified portfolio and a focus on the long term are often better defenses than trying to time the market.
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Investors would often ask why is diversification important - put simply diversification means spreading your money across a range of assets. Over the long term assets such as shares and bonds have tended to produce positive returns; however, in any particular year, some assets may rise in value and some may fall. So by spreading your money across a range of assets you can reduce the impact of losses on a single one of these assets.
Assets can react differently to market forces. Some may react positively and others negatively. By holding a range of assets, losses in one part of the portfolio are likely to be offset by gains elsewhere. For example, the prospect of higher inflation can be negative for bond markets, as the income available from bonds is usually fixed, and therefore it’s less valuable when inflation is rising. However, stock markets have tended to cope better with inflation, partly because companies can put up prices to combat higher inflation, which in turn is reflected in their share prices. Therefore diversifying your portfolio between stocks and bonds and other types of investments can provide more attractive risk-adjusted returns and therefore a smoother investment journey.
So how should I go about diversifying my portfolio? There are several levels of diversification, all of which are important to consider. As well as investing in a range of asset classes, such as bonds and equities, it is also important to diversify within this. When investing in an asset class, it’s important to consider investing globally, as it allows you to capture the growth potential in both developed and emerging economies. It also prevents you from being overly exposed to the performance of one country or region, as different markets have tended to produce different returns over time. For example, in 2001 and 2004, emerging market equities significantly outperformed UK equities, but for the last five years the opposite has occurred.
You could further diversify by investing in companies within different market capitalisations, such as large cap and small cap. Shares in fast growing smaller companies have tended to offer the prospect of stronger returns than larger blue chip companies, but they can also be much more volatile. As a result, investing in small cap stocks can be riskier than investing in larger companies. Funds can also be a simple solution for investors looking to build a diversified portfolio.
As a fund manager, we hold a wide range of investments within an individual fund; shares in lots of companies of bonds from a range of issuers which limits an investors exposure to the fortunes of any one company or market. There are thousands of investment funds available which target various asset classes, geographies and sectors, from American small cap companies to emerging market bonds. Selecting the right funds to achieve a diversified portfolio can also be challenging, and therefore some investors may prefer to invest in a single multi-asset fund.
So therefore what are these multi-asset funds? Multi-asset funds are a single fund that invests in a range of asset classes. A multi-asset fund could act as a single investment solution providing diversification across and within the different asset classes. Multi-asset funds can vary significantly and it is important to look at the allocation to assets to ensure they reflect your appetite for risk and reward. Generally speaking the larger the proportion of equities the riskier it is considered to be. In order to provide an example, I will show one of the multi-asset class portfolios I manage and how we have looked to diversify within this.
This is just one of the six actively managed multi-asset class portfolios. Each of which has a different long-term asset allocation split to suit different risk and reward profiles. This particular portfolio is called the balanced portfolio, which could be thought as having a medium risk and reward profile. The long-term asset allocation for the balanced portfolio is a 53% allocation to equities, of which 43% is developed market equities and 10% is emerging market equities. A further 28% is allocated to bonds, both government and corporate in emerging and developed markets; 12% is spread across commodities, real estate and alternative trading strategies; the final 7% being allocated to cash and short maturity bonds.
For each of the asset classes, we diversify further by looking for the best third party fund managers, which we feel complement each other very well in terms of style or focus. For example, the 10% allocation to emerging market equities is spread across six different fund managers. They all have different styles and focus, and they have been selected as they complement each other and provide different insights. In this case Schroder’s, Somerset Capital and Pzena Investment Management can invest across all emerging markets, but have different approaches to investing, whilst Arrowstreet, Arx Investments and East Capital focus on specific emerging market regions. For example East Capital focuses on emerging European equities. The team has a strong network in the region and looks to access less researched companies where they feel they have an edge.
So hopefully this helps demonstrate the additional diversification that can be achieved by investing in managers with different geographic focuses, skills and approaches to investing. It’s nevertheless important to bear in mind that no matter that you might diversify your investments you can still lose money as their value can fall as well as rise.
In this video, Barclays’ Jaime Arguello talks about diversification and why it’s important when investing – giving you tips on how you could achieve diversification within your portfolio.
An opportunity to invest?
Attempting to time the market can be a high risk approach, especially when compared to making ongoing regular investments. If you think it could be an opportunity to invest while share prices are lower to potentially make higher returns over the long run - just be mindful that prices may fall even further, and that past performance isn’t a reliable indicator of future returns.
Coping with market volatility
Whenever the prospect of a sell-off seems to be particularly severe, there is a temptation to reduce exposure to the market. Once the threat has diminished, we can buy back in, hopefully at lower valuations.
However, it is almost impossible to distinguish between a genuine, imminent crisis and a mere market wobble over an event that ultimately proves far less serious than anticipated. As a result, investors who spend too much time waiting for the right moment to invest may miss out on many of the gains.
For example, over the last five years, some investors have kept a large part, or all, of their cash on the sidelines. In waiting for the global economy to become a safer place, they have missed out on very significant gains in most asset classes though of course they might have lost.
The implication is that unless markets are clearly extremely overvalued, your best approach may be to stay invested and try to manage the psychological effects of high volatility. That’s assuming, of course, you are investing for the long term.
Focusing on the long term is more easily said than done, but adopting a sensible strategy of diversification should temper the volatility of your portfolio. This means both diversifying within asset classes and among asset classes.
For example, a fully diversified portfolio of stocks will be less volatile than holding just a handful of stocks. No matter how effectively you diversify though, your investments can still fall in value so you may get back less than you invest.
Investors should also consider whether they want to diversify their stock holdings globally, rather than confining themselves to the UK market. In doing so they could benefit from the different performance of international markets.
Note, however, that international diversification can expose investors to another form of volatility: foreign currency risk. This is where the value of investments can fall owing to a decline in the sterling value of foreign currencies.
When you invest with us, we’ll support you with cutting-edge research, independent analysis and useful tools to help you review the market and feel more confident when making your investment decisions, including;
Stock alerts – Be the first to hear when a share price reaches a certain level, or rises or falls by a certain amount or percentage. You set the share price and price movement you want to monitor, and we’ll send an email notification if and when it happens.
Market insight alerts – Receive free market movement information including a daily pre-market report highlighting stocks to watch; a daily report keeping you up to date with the latest newsworthy events in the market; a weekly summary of key dates and announcements for the coming week.
Order Types - When you buy or sell shares, you can set conditions on how the investments are bought and sold – e.g. buy or sell at a certain price or time – using order types. These are advanced tools that help you manage your investment strategy effectively, even when you’re not actively watching the market.
Henk Potts’ Market Review – Henk Potts is Barclays Global Investment Strategist. You can listen to, or read, his weekly market review in which he analyses a wide variety of asset classes, including equities, currencies and commodities, as well as ascertaining and explaining the effects of macroeconomic changes on financial markets while on the move.
Investing and trading articles – We present the latest market movements, key trends and industry analysis.
No matter how you use our market insights and tools, investments still carry risk. If you’re unsure about whether an investment is right for you, please seek independent advice.
If you’re ready to invest and add to your portfolio, just remember that all investments can fall in value and you may get back less than you invest.
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