Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking with Kathrin Forrest, investment specialist with Capital Group about market volatility. We talked about investor traps, the importance of portfolio checkups, and we started by asking if the current moment is unusually turbulent by historical measures.

Kathrin Forrest (KF): You know, clearly, the market backdrop feels a lot less settled than usual. In this context, when we look at how this has translated into market volatility, for equities, one of the proxies we can use is the VIX index. And this index measures the stock market’s expectations of volatility. Until fairly recently, volatility had been largely trending down over the past year, with the exception of a brief spike around the U.S. regional banking crisis in March. And that’s in contrast to the MOVE index, which measures bond market volatility. And here we see that interest rates have remained unusually volatile over the past 18 months. With the exception of a brief spike in March 2020, we have to go back to 2009 to see similar levels of volatility. The gap between bonds and equities, in terms of volatility, has started to close over the past month or so. The bond market has been volatile for quite some time. Unusually so. Equities not so much, until very recently.

Investor traps

KF: One trap that comes to mind is loss aversion. If your goal is to grow wealth over some longer period of time, inflation is [an] important factor to think about. So, if you invest your money overly conservatively, you may risk eroding purchasing power, if inflation tracks above your investment returns. And, on the other end of the spectrum, during volatile markets, anchoring to recent reference points may make asset prices look cheap after recent selloffs. But things don’t always revert back to the mean, certainly not over shorter periods of time. So, either way, deviating from your investment strategy can be dangerous because it can take your overall portfolio off track.

Portfolio checkups

KF: In choppy markets, asset prices can overreact, driven by things like overall sentiment or liquidity. And that means that prices may not do a great job reflecting fundamental values. You don’t necessarily need to read too much into that, but you want to make sure you understand it. In such an environment, your asset mix might drift quite a bit as well, and that can take you too far off target. And another feature that might change is the liquidity profile of your portfolio. Building blocks that you thought might be liquid may not turn out to be easy to trade in a volatile market. So, at a high level, don’t necessarily get overly focused on short-term price fluctuations. But what you might want to consider is checking your portfolio against your objective, and any important guidelines and constraints that you might have, such as around income or liquidity.

Expanding investment horizons

KF: It’s important to think about your time horizon during volatile markets. Assume your expected return is 8% per year, and risk — measured in standard deviation — is 10%. This means that over longer periods of time, your average annual return is 8%. But in a given year, you have an over-15% chance that your return is lower than minus 2%. It’s pretty easy to lose confidence. But it’s just part of the normal journey towards that 8% average long-term expected return. A year of minus 2% is not out of the realm of expectations. So, the opportunity in the unsettled environment that we’re finding ourselves in today lies in finding companies that can thrive under various different circumstances. And that is through leaning into fundamental research and applying a global lens.

And finally, where she sees opportunities in the current moment.

KF: Focusing on bottom-up company features, rather than top-down factors may help navigate more successfully through various different potential macro environments. We continue to focus on and find companies that may benefit not just from one particular macro theme, but more broadly from features such as, you know, structural growth opportunities, for example, through innovation, changing industry dynamics, improving operating performance, industry-specific tailwinds, or shareholder-friendly capital allocation. So, it’s the thought that we can find differentiated drivers of return at a company level that can collectively thrive in various different environments.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Kathrin Forrest of Capital Group. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.


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