How to Manage Volatility

Investors must always expect ups and downs on the stock market, but these fund managers offer some tips on how to limit volatility

Annalisa Esposito 21/05/2020 16:18:00
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rollercoaster

While investors must always be prepared for ups and downs on the stock market, this year has been a particular rollercoaster ride thus far. After gaining new highs in January, markets plunged in March as economies across the world went into lockdown, and have since made a patchy recovery at best. Indeed, the Vix index - widely used a measure of volatility on stock markets - hit a record high in March as fears about the impact of Covid-19 ramped up. 

Volatility Managed funds aim to provide investors with a smoother journey. While the specific aims of each fund in this group varies, they are all trying to avoid the sharp swings in performance that have caused many investors sleepless nights in recent weeks. 

We asked some of these managers for tips on how they manage volatility:

Look for Defensive, Quality Equities

The type of companies you invest in makes a great difference to the volatility you endure. Nathan Sweeney, co-manager of the Architas Multi-Asset Active Fund range, likes to focus on quality rather than value stocks.

He believes that a bias towards quality growth companies - those which have reliable earnings and competitive advantages - is a good thing in a sell-off such as we saw in March.

While the tech sector may not always have been an obvious hunting ground for such stocks, the move to online shopping in recent years and the ramp up in home working of the past few months has rendered many of these services essential.

A favourite investment in the sector is Amazon. “When you think of Amazon, you think about distribution,” he says. “With just a click something gets delivered to your door.” It's a strategy the e-commerce giant has spent time and money perfecting.

Also Simon Holmes, a manager in the BMO multi-strategy team, also favours defensive sectors such as tech, healthcare and consumer staples. In particular he likes names such as Microsoft and Uniliver. Microsoft is a resilient business and software demand has been increasing. He adds: “Uniliver is a strong brand, has a long heritage and makes items that people need.”

Don’t Invest in Anything Quirky

While some managers look to specialist and alternative assets to inject some diversification into their portfolio, Sweeney insists it's better to avoid anything too niche. He says: “In fixed interest, for example, we like government bonds rated triple BB and double BB. We have no exposure to quirky investments that tend to sell off more during a distressed market.”

Similarly, Holmes is wary of high yield bonds, many of which are issued by companies in the energy sector - an area he thinks will continue to struggle. “I like investment grade bonds. They are attractive at the moment." he says. "The energy sector is bouncing back, but there are still challenges for it as demand continues to shift [away from fossil fuels]."

On a country level, Sweeney prefers the US and avoids Europe, even though he admits it looks enticingly cheap by comparison: “We like the element of growth in the US and the focus on the quality aspect of the market has helped us.”

Stay Alert

Volatility spikes and it can happen fast, as investors have already seen this year. Holmes says avoiding such spikes means rebalancing an investment portfolio regularly and being aware of the macro-economic environment across the world. 

“When things started to become more uncertain at the beginning of the year, for example, we started to reduce the risk in our portfolio by cutting down on high-yield investments and reducing our equity exposure," he explains. At the same time, he increased his position in inflation-linked bonds as pandemic worries started to expand from being just a minor, peripheral risk.

Sweeney, meanwhile, has cut down exposure to property, particularly as a number of open-ended bricks and mortar funds started to suspend trading. He also uses a modelling tool to track volatility; a quarterly update helps make decisions about how to position portfolios for different risk tolerances. 

But while it’s true investors should stay alert and be wary of the various macro-economic scenarios, Morningstar analyst Bhavik Parekh points out that it's also vital that investors don’t forget about their long-term goal. He adds:"When investing for the long term, riding out these volatile periods is a must as markets move quickly and you could miss out on a recovery if you don't remain invested."

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Annalisa Esposito  is a data journalist for Morningstar.co.uk

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