Transcript: Sideline is no place for investors, even in turbulent times
Jack Delany of Dublin-based Irish Life Investment Managers says markets reward those who employ risk-reduction strategies in difficult environments.
- June 21, 2022 June 21, 2022
Welcome to Soundbites, weekly insights on market trends and investment strategies, brought you by Investment Executive and powered by Canada Life.
In today’s episode, we speak with Jack Delany, quantitative portfolio manager with the multi-asset team at Irish Life Investment Managers. We talk about risk reduction strategies, how multi-asset funds can reduce volatility, and we started by asking if eliminating systematic risk from a portfolio is even achievable.
Jack Delany (JD): Markets have undoubtedly experienced a difficult start to the year, driven by both geo-political and macroeconomic events. But we would caution, however, against saying that systemic risk is unusually high. Markets do invariably go through rocky patches over time and a key feature of portfolio design is positioning for the long term, while ensuring that portfolios are robust through a range of different environments. As to whether or not systematic risk can be eliminated, we would say this is not a realistic goal for most investors. Taking some risk is a necessity when it comes to generating returns.
How multi-asset funds reduce volatility.
JD: Firstly, they can use diversification. The most common form of diversification we often see is across equities and bonds. But even this won’t always work. 2022 is a great example with both equities and bonds in negative territory. We consider the role of alternatives as a source of less-correlated return streams. Many alternative strategies have actually outperformed both equities and bonds year to date. We can also look for diversification within asset classes, spreading ourselves across geographies, styles, etc. The second thing we can think about is risk-reduction strategies. These can be either explicit risk-reduction strategies that purchase protection against an underlying asset or implicit risk-reduction strategies that allocate to more defensive exposures or that dynamically manage exposures at different points in the cycle. Both of these approaches, though, can be combined to manage losses and deliver a smoother return profile for investors.
Currency risk in a tumultuous environment.
JD: Yeah, currency exposures are really important drivers of portfolio risk. And due care and attention need to be given to these positions. For a Canadian-dollar-based investor, we’re going to think about currencies relative to the Canadian dollar. The Canadian dollar would often be considered as one of the more cyclical developed-market currencies, while at the other end of the risk spectrum we’d have currencies like the Japanese yen, the Swiss franc, maybe the U.S. dollar, with more of a safe-haven risk-off return profile. Maintaining some exposure to these currencies can be a useful source of potential risk management, given their potential to outperform relative to the Canadian dollar in times of market turmoil, and in doing so, provide a measure of insulation to investors against portfolio losses. However, we can’t rely on these relationships to hold all the time. If we take this year, for example, the Canadian dollar has actually appreciated against many of its developed market counterparts, despite its status as a so-called cyclical currency. And that’s largely given the moves we’ve seen in commodity prices year to date. So, a diversified approach here is going to be key. We typically favour some degree of currency hedging, particularly on the fixed-income portion of a multi-asset portfolio. But for CAD-based investors, leaving some foreign currency exposure unhedged, for example on the equity portion of the portfolio, does give the potential for loss mitigation.
Managing volatility in a bear market.
JD: We really favour risk-mitigation strategies that deliver the potential for both protection in down-markets but also participation in up-markets. Examples of useful strategies includes collar option strategies, where we use put options to protect against losses but still leave room for some up-side participation; low-volatility equity strategies — long-only equity strategies — that target more defensive, lower-beta, lower-volatility allocations; and finally, tactical allocation strategies. These are strategies that use a range of factors to formulate a holistic view of market conditions in order to systematically reduce their equity allocation when the outlook is not favourable or to increase it when the outlook improves. All three of these strategies provide great opportunities for investors to participate in strong markets, but also provide protection against large losses.
And finally, what’s the bottom line for advisors who wish to insulate their clients from ongoing volatility?
JD: There are a number of key takeaways. The first is that we need to understand that some risk is necessary in order to generate return. Second, is that despite the necessity to take some risk, it is still possible to do this intelligently. A robust asset allocation process, underpinned by both qualitative and quantitative analysis, in our view, goes a long way to ensure our portfolios are appropriately positioned to harness the power of diversification and risk management and deliver that smoother return profile that we know investors want. What we’re looking for are strategies that have the potential to manage losses, while still allowing for some up-side participation.
Well, those are today’s Soundbites, brought you by Investment Executive, and powered by Canada Life. Our thanks again to Jack Delany of Irish Life Investment Managers.
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