August 07, 2013

Keeping a Cool Head in Volatile Markets

Capital markets can be fairly quiet in the summer, when many investors go on vacation and take breaks from their portfolios. This hasn’t been the case this year, however, as equity markets around the globe saw volatility in June and July. Memories of the crash of 2008 persist today, leaving many investors with limited tolerance for risk. They may feel an urgent need to adjust their portfolios, but might lack a clear idea of how or why.

Canadian equity markets started the summer with fairly large swings, due in large part to weakness in gold and material stocks, which continued their decline of 2012. Foreign equity markets have been strong so far in 2013 and the U.S. equity market has reached record heights recently.

Bonds, traditionally a safe haven in times of stock volatility, offer little comfort for nervous investors. With interest rates at historically low levels the outlook in the short term is weak at best, reducing the number of attractive investor options.

With all this volatility and uncertainty, it’s little wonder some investors are looking to make portfolio changes. Before they do, though, they should review their investment objectives and determine what is behind their desire to make a change. Are they reacting to market volatility or have their personal circumstances changed? Retail investors have historically performed worse than the funds they invest in, due to attempts to outguess the market’s direction or “time the market.” In many cases, investors would have been better off sticking with their strategy and riding out the volatility rather than jumping from one asset class to another.

After a period of strong equity market performance, it is important for investors to review their overall portfolio asset mix (the balance between stocks, bonds and cash) and adjust it back to the target if the asset mix has changed significantly. If an investor’s objectives have not changed, there may be no need to adjust the long-term strategy, but trimming back some of the better performing areas and realigning the portfolio may be prudent. This becomes particularly important as investors approach retirement.

By reviewing their investment objectives, considering their investment time horizon and risk tolerance, investors are often able to refocus on their goals and recognize that making a change, based on emotions, may not be warranted. If investing for the long-term, recognizing that you don’t need to draw income from the portfolio in the near term can often help ride through market volatility. Equities provide the growth for portfolios over the long-term but are potentially more volatile in the short term. Investors drawing income from their portfolios should not have all of their assets in aggressive, growth-oriented stocks. Dividend-paying stocks and high-quality corporate bonds may be an option to consider. But speak with your investment funds advisor before making any changes to your portfolio.

Another strategy that allows investors to weather market volatility in the markets is to think about price or valuation. Logically, we understand we are better off if we buy things when they are “on sale” and sell things when they become expensive. When we buy consumer products, we have no problem with this principle. For some reason, this rationale reverses for investors: they want to buy things that have been performing well (i.e. that are expensive) and sell things when they have declined in value (or are cheap). Bonds have enjoyed several decades of good performance due to declining interest rates and are unlikely to deliver the same strong results they have over the last 10 years. Many bonds, especially government bonds, look expensive to us currently. This doesn’t mean investors should abandon bonds as they provide income and offset some of the volatility of the equity markets. Considering the types of bonds held in a portfolio is important now.

The key to investing during volatile times is to make sure your portfolio lines up with your objectives and to stay focused on the big picture rather than allowing emotions or market noise influence investment decisions in the short term. Having their investment strategy written down in an Investment policy statement helps investors keep on track during uncertain times.

This article is not intended to provide advice, recommendations or offers to buy or sell any product or service.  The info provided in this article is compiled from our own research and is based on assumptions that we believe to be reasonable, accurate at the time the report was written, but, is subject to change without notice.

Karey Irwin

Principal, Portfolio Manager - Private Clients & Foundations