Stock market crash with red chart in background and bear in front. Bearish market trend concept.

The volatility sweeping global equity markets makes it impossible to accurately forecast what will happen next in a prolonged period shaped by financial uncertainty.

This summer will be bumpy — and not nearly as fun (or as predictable) as the roller coaster at your favourite theme park. Autumn may not bring relief even if central banks prudently intervene to smooth out the ride.

We at the Canadian ETF Association (CETFA) believe ETFs can contribute effectively to your clients’ portfolios in a jarring investing climate.

ETFs offer distinct advantages for tackling tougher markets

ETFs are not insulated from the issues facing today’s economy. But they can present client- and advisor-friendly solutions. And, depending on a client’s needs, goals and time horizon, there could be an upside: the stock market is “on sale.” With other investors, the silver lining of accepting a capital loss on their investment may come from gifting it to a cherished cause for the tax credit.

While ETFs and other market-based investments, such as mutual funds and individual equities, inevitably respond to market change, their differences are striking. ETFs provide the risk-mitigating diversification that individual stocks and bonds cannot and (typically) at a lower cost and with greater tax efficiency than mutual funds.

ETF fund managers, including active managers, don’t need to sell significant holdings to satisfy rising redemption orders as mutual fund managers may be forced to do, triggering capital gains. ETFs may therefore be better accepted than mutual funds by increasingly fee-sensitive and value-conscious investors for whom the client-focused reforms (CFRs) have made investing costs more transparent. (Detailed client dialogues about products and associated risks obligated by the CFRs may also alleviate hindsight regrets about product selection.)

Understanding today’s realities benefits from an on-the-ground perspective

To gain more perspective on the complexities of volatility, we also sought out insights from several member companies to help you manage your client relationships through the hurdles you could encounter.

“We’re in an unprecedented, never-experienced-before economic cycle driven by the pandemic followed by a stimulative axe from government to revive the economy,” said Lisa Langley, founder and CEO of Toronto-based EMERGE Canada Inc. “Now there are supply chain issues, other hiccups and a war in Europe that has accentuated fuel costs. So there’s a trifecta of conditions causing volatility. We’ve never been here before.”

Bill DeRoche, chief investment officer with AGF Investments LLC, also underscored the extraordinary circumstances: “We’re in a different regime now. Previously, there was an expansionary period, but from the first week of November 2021, inflation has been the primary concern for most central banks; it’s the first experience with inflation for most investors. For many people, this is a new conversation.”

Observed Randall Alberts, senior vice-president and head of distribution with CI Global Asset Management: “It’s important to remember that bear markets are relatively short compared to bull markets.” The S&P 500 fell 2% or more for 41 trading days in 2008; however, the economic expansion between 2008 and 2020 lasted for 133 weeks and the S&P 500 grew by 528.9%. “Never before did we have such low interest rates for so long, or the pandemic, or the digital information processing that has potentially heightened the impact of volatility.”

ETFs’ innate strengths mean they can perform well in all market conditions

Five to 10 years ago, the ETFs available to Canadian investors were rather “vanilla,” but now they’re much more sophisticated, DeRoche said. “It’s important to educate clients that ETFs respond to different environments, that they’re so differentiated they can support many investment strategies and can perform well in all conditions. Investors can get the ‘flavour’ they need for their specific portfolios.”

ETFs allow for easy access, diversification, liquidity and transparency into the underlying holdings, Alberts said. “These attributes let investors better position their portfolios according to their risk tolerance and time horizon. Intraday pricing means ETFs have much more liquidity and can respond more rapidly to changing situations. These are advantages in volatile times.”

Commented Langley: “If you’re truly an investor, you’re investing over different time periods. Volatility lends itself well to dollar cost averaging with ETFs and to choosing a strategic mix of ETFs that suit different time horizons.” And you can buy certain ETFs at historic lows with the potential for future long-term growth: “Dollar-cost averaging is being used to gain units at a lower price.”

Product types that could be a good fit in today’s environment include liquid-alt ETFs, which can deliver diversification and downside protection and minimize drawdown. Advisors may also want to consider smart-beta ETFs, covered-call ETFs and divided-focused funds to cushion the impact of volatility.

All equities-based ETFs are exposed to market forces. However, correlations can differ, so portfolio-level volatility can be mitigated by choosing the right mix. For example, an ETF that deploys a hedging strategy can reduce the impact of drawdowns and deliver the potential for positive returns with lower portfolio volatility.

Alternatively, a broadly diversified factor-driven ETF that focuses on infrastructure investments may feature less volatility and the potential for higher yields. Investors with a long-term outlook may still want to consider innovation-focused ETFs. These funds (and their underlying stocks) are taking the brunt of the market drop right now, but against slower near-term growth projections, such ETFs can be the right strategy for countering inflation.

A number of CETFA-affiliated firms offer ETFs designed to manage risk, and there even more products that could satisfy the needs of your risk-averse clients.

CETFA members, including those we interviewed, also produce a variety of educational resources to help you and your clients navigate investment management options and make more clear-headed decisions. The strategies and tactics they deploy include readily accessible dedicated service teams, webinars shared via YouTube, sponsored articles in the business press, as well as supportive content shared via email, extranets, websites and social media.

Advisors can put volatility to work for clients

What did these members foresee about a change in current patterns, and what other considerations should advisors heed as they guide clients through the turbulence?

“We’re in a high-inflation environment; it is pernicious and we have to deal with that. But the good news is that the Fed will fight it…I don’t see a recession anytime soon,” DeRoche said. For now, advisors can address drawdown risk through the right ETFs but should cautiously avoid promissory exchange-traded notes because some closed very quickly as a result of volatility, he added.

“Volatility is not a bad thing and it’s here to stay,” Langley said. “It always goes back to why investors are investing, what their objectives are and to taking advantage of volatility. They’re trying to cool down the economy, and I believe a soft landing is possible. It’s just going to take awhile to get back to where we were.”

Uncertainty is the single biggest driver of volatility, Alberts said, and the circumstances create an opportunity for advisors to differentiate themselves: “Lean in and be present and accept the stresses of challenging times. Go back to your shelf and look at the ETFs that may be best suited to difficult markets.”