Where to focus when markets are volatile

The US invasion of Iran, oil price spikes, bubbles in the artificial intelligence sector, government debt, market losses, market gains. The news is constantly changing. Amid uncertainty, markets respond with heightened volatility.

Volatility is high, risk is high, but opportunities arise because markets are volatile, Sebastian Mullins, head of multi-asset and fixed income at London-based global manager Schroders, told the recent Investment Forum hosted by the Collaborative Exchange in Cape Town and Johannesburg.

And because of these opportunities, if you look back in 30 years’ time, you will be grateful you did not withdraw and run for the hills when markets swung wildly one way or another on the back of the latest disruption, Pieter Koekemoer, head of Personal Investments at Coronation Fund Managers, argued at the same conference.

If you can endure short-term volatility and stay invested for the longer term, you will benefit from the growth markets can deliver and the magic of compounding that really becomes evident in the later years of your investment term, Peter Kempen, head of distribution at Coronation, added.

Kempen’s arguments were reinforced by Dr Ryan Murphy, the Global Head of Behavioural Insights at Morningstar Investment Management, who said his favourite graph is one that tracks global stock prices over the past 150 years as it shows clearly how money invested in markets can enable investors to accumulate wealth that compounds over many years.

Murphy says the chart also shows that growth does not happen in a straight line – there are periods of substantial market volatility during which time investors’ portfolios can show losses.

Don’t check your investments too often

Volatility is often very distracting for long-term investors and it is well-known that investors are hypersensitive to losses, Murphy said. Gains feel good, but losses hurt more – a concept known as loss aversion, he said.

When you see losses in your portfolio, loss aversion can result in a strong urge to disinvest and lock in the losses.

The more often you look at your portfolio, the more volatility you are going to see, Murphy said.

His research shows that investors who check the same investment portfolio:

• At the end of each year, will see their investment values up on average about 74 percent of the time;
  
  
• At the end of every quarter, would see investment values up on average 70 percent of the time;
  
  
• At the end of each month, would see investment values up on average 63 percent of the time;
  
  
• At the end of each day, up on average only 54 percent of the time.

When your investment isn’t performing over the short-term it is easy to get distracted by opportunities to switch to something new with, for example, a three- or five-year track record of doing well, Koekemoer said.

But managers who can see a disconnect between the price of a share or other security and its actual value may underperform an index at times. It puts a lot of pressure on investors and managers. But if you're making the right decisions at those points in time, you really are capitalising on the opportunities that are presented as a result of volatility and mispricing, he said.

Focus on your goal

Murphy said another thing you can do to avoid being distracted by volatility is to make your goals the centre of your attention and focus on your timescale for those goals.

This was advice that came from a panel of successful financial advisers around the world that Morningstar canvassed about their experiences with investors when markets were in turmoil.

If, for example, you are investing for retirement over a 26-year working life, it is useful to see the performance of your investments over this timescale as it puts any volatility in context.

You can see that a little squiggle line on a long-term market graph is what the talking heads on TV or the headlines are screaming about, Murphy says.

The rest of the graph should show how you are accumulating wealth and that you will have the money you want when you need it to do what you want with it, he said.

Have realistic expectations

Murphy said while no one can tell you exactly what your experience invested in the market is going to be, it is possible for advisers to set out probabilities based on data from the past, so that you can have realistic expectations about how your investments could perform and the range of outcomes within your timescale.

You will definitely face ups and downs, and an adviser should quantify what that could mean, Murphy said. For example, you should know that if you have a R1 million and the market falls 20 percent, your investment could show a loss of R200 000.

Being an investor is unnatural given how brains are wired, Murphy said. It requires us to be patient, delay gratification and embrace uncertainty by taking investment risk to earn rewards.

Expect more volatility

Niel Padoa, portfolio manager at Coronation, told the Investment Forum markets are currently displaying massive distortions that are a result of investors, like index-tracking investors, who are not concerned about the fundamentals of the investments and who have ultra-short investment horizons, driving prices to irrational levels.

Padoa said single-stock volatility had tripled over the past 25 years and this is likely to be further amplified by AI.

Markets are no longer efficient at pricing shares, he said. But for investors who are able to invest long-term based on the fundamentals, this creates tremendous opportunity, Padoa said.

Amid this disruption and change it is incredibly difficult for companies to remain at the top of their game for extended periods, he said. Active managers who research securities, however, are better equipped to identify winners and losers.

Look for more ways to diversify

Mullins said in volatile investment markets, investors need more defensive, robust portfolios, especially since the traditional way of diversifying between bonds and equities no longer works as a result of higher inflation.

He said the war in Iran has seen the oil price spike, which means inflation is rising.

“We don't think it's going to last for a long time, and hopefully it gets done quickly. But the longer or higher the oil price goes, the more that real wage growth will be eroded.”

This could undermine economic growth that comes from consumer spending.

Mullins said this could be offset by government spending which is rising around the world and could raise inflation for a longer period than any short-term shock from a quick war.

The outlook for global growth is good, but the US is no longer the only place to be invested and valuations need to be taken into account, he argued.

As you watch markets seesaw, you can also take comfort in the fact that after all big geopolitical events since 1940, the leading US market index, the S&P 500, has been higher 85 percent of the time, Greg Hopkins, deputy chief investment officer at PSG Asset Management, told the conference.

Hopkins said if the war extends and an energy crisis emerges, investing in energy shares will be a hedge against any negative effects. There has been underinvestment in energy over 10 years and there is rising demand, particularly now through new sources of demand, such as AI, he added.