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Elevated equity valuations and a global economy hopped up on stimulus could bring even greater levels of volatility to the market, according to Anthony MacGuinness, head of the quantitative strategies group at Irish Life Investment Managers in Dublin.
MacGuinness said advisors should place a new emphasis on diversifying portfolios, finding new growth opportunities and managing risk proactively.
For example, real estate, infrastructure and alternative investments offer a more attractive risk-reward relationship over the long term than fixed income, he said.
Beyond diversifying, however, investors must also look at risk mitigation in a new light.
“Diversification within equities — across styles and regions — is certainly one way,” he said, noting that while valuations are high, they are “sustainable” once you consider the low levels of bond yields.
“We do see valuations in the U.S higher than the longer-term averages,” he said. “If we’re looking at their price versus the next 12-month earnings, they could be trading at 20 times in a year. However, if you compare that valuation versus 2022 earnings, we’re looking at a valuation multiple of around 17-and-a-half times.”
MacGuinness added that equities were trading around 24 and 25 times earnings prior to the tech crisis of the early 2000s.
Another risk management approach is to employ tactical asset location while monitoring market sentiment and analyzing macroeconomic factors.
Thirdly, he uses derivative or option strategies to mitigate the potential losses that come with investing in riskier securities such as growth assets, which he said are likely to outperform defensive assets in the long term.
“Derivatives can play a role in terms of reducing that overall level of risk that the investor is taking, through buying [downside] protection. Protection is expensive but we fund that protection by selling away some upside in the market.”
MacGuinness said that despite recent market growth of about 30% since October, there are still opportunities for investors.
“We believe the outlook for global equities and risk assets is still well supported,” he said. “We believe the stimulus that we’re seeing from monetary and fiscal authorities will prove supportive for risk assets.”
He cautioned, however, that investors need to be mindful of the lasting impacts of the stimulus money, and how governments will tackle increased debt levels in the future. The risk of inflation returning is real, he said.
“If we do see inflation increase, I think that could cause quite a destabilizing impact for investors in their portfolios,” he said. “Inflation pressures look contained at the moment, but it is probably an underpriced risk to the market, and we need to be considerate of that.”
MacGuinness acknowledged that more stringent risk-management solutions tend to be good at taking investors out of the market, but not as effective at getting investors back into the market to experience stronger returns.
“We know investors will need to stay invested for longer to be able to deliver what they need, in terms of their financial objectives and financial security,” he said. “So as advisors and asset managers, we need to put solutions in place to support that. And we believe the areas where we can do that best is by looking to higher and greater diversification and risk management as integral components within portfolio construction.”
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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.