How to invest in volatile markets.
The start of the year was characterized by high volatility on financial markets – a situation that is likely to persist for some time. That makes it all the more important to adopt the right approach to securities. Investor recommendations for a well-equipped portfolio in turbulent times.
Guide to investing in equities in turbulent times
For financial markets, the start of the new year was marked by uncertainty and a weaker trend. The fact that central banks are planning to withdraw liquidity from the markets was reflected in a rise in the VIX volatility index to over 30 points – the highest level since January last year. In total, the S&P 500 – the leading US equity index – and its Swiss equivalent, the SMI, both shed over 5% of their value in January. Whether things will continue in a similar vein for the rest of the year is an open question.
In the view of the Credit Suisse experts, the current correction is more of a panic attack rather than a harbinger of lasting downside movement. Nevertheless, the factors that caused heightened levels of volatility on markets in recent weeks are likely to make themselves felt for some time to come. These three recommendations should help investors navigate their way through the volatile environment as safely as possible.
1. Sit out the volatility
Keep calm, think long-term, and stay invested: We know that having a long-term perspective is one of the most important lessons for investors. Volatility is part and parcel of investing – as are paper losses. Double-digit price falls occur almost every year.
A glance at the past shows that the best and worst days on the stock exchange are close together. Accordingly, an emotional response to volatile markets can potentially do more harm to the performance of the portfolio than the market fall itself. Despite volatile markets, Credit Suisse therefore recommends that investors do not depart from a long-term investment strategy geared toward their personal return and risk objectives.
2. Diversify effectively
No asset class performs well all the time. However, diversification does create staying power – even in turbulent times. The diversification benefit is accentuated as the correlation between asset classes decreases. Investors should therefore think about diversifying not only across different asset classes but also across various sectors, regions, and themes. This will protect the portfolio against the negative impact from individual securities.
Diversification reduces the degree of fluctuation in the portfolio over the long term, while at the same time increasing the potential return. However, keeping a well-diversified portfolio for the long term is not easy – because even if a portfolio seems to have the perfect balance in the beginning, the weighting of the positions will change over time due to different developments in performance. These changes must be balanced out continuously by making changes to the portfolio.
3. Review the equity component
The combination of accommodative monetary policy, zero interest rates, and massive share buyback programs has resulted in investor portfolios showing a steadily rising equity component in recent years owing to the lack of alternatives. Against this backdrop, it is worth reviewing the equity component in your own portfolio:
- Equity quota too high:
If the proportion of equities in the portfolio is too high compared with the target allocation, a reduction in the equities quota through selective profit-taking is recommended. In addition, partial reinvestment in investment modules with a lower systemic risk, such as alternative investments, can be worthwhile, depending on the situation.
- Equity component too low:
If the equity component of the portfolio is lower than the target allocation, the current higher degree of volatility also presents opportunities. Investors can take positions in selected sectors, regions, and themes that will benefit from either the overall macroeconomic environment or strong structural factors. Opportunities are likely to arise in European financials and healthcare stocks, as well as Japanese and Italian securities. Accumulation strategies for the gradual purchase of equities based on a prescribed pattern help to mitigate short-term risks and spread entry points.
- Equity component correct:
Adequate diversification not only across the different asset classes but also within individual asset classes pays off in the long term. If the portfolio's equity component is in line with the long-term strategy, it is worthwhile reviewing the country allocation as well as thematic/sector weightings.