12th May 2017
The Death of Volatility?
For the best part of 9 years the markets have been awash with monetary stimulus. Whilst there is no doubting the honourable intentions behind the introduction of Quantitative Easing (QE) in 2008 – providing an emergency liquidity injection to an imploding financial system – 9 years on it has become so pervasive that neither politicians nor capital markets can do without it. This wall of central bank money has brought on a collapse in interest rates, credit spreads and general market volatility. But more worryingly perhaps, it has encouraged complacency amongst the investor community. So are we to believe then that market volatility is a thing of the past? That central banks will set the price of assets for evermore? As red-blooded active managers we sincerely hope this is not the case. Nor do we really believe it will be.
Perhaps our greatest challenge as fund managers is attempting to make sense of today’s market environment. Much of our macro research is based on attempting to understand not only the direction of the global economy (in terms of growth and inflation) but also the scale and direction of global liquidity flows. Our analysis continues to tell a story of easy financial conditions providing fundamental support to asset prices. Any pickup in volatility is in our view most likely to be sparked by a tightening in these conditions. This of course could come from any number of sources, whether it be geopolitics, policy disappointment (Trump), a nasty surprise in China, or indeed an unwinding of central bank balance sheets. As ever we remain vigilant, and more than happy to discuss any of these points in far greater depth should any of you so wish.
How to Manage with Volatility
Without having the ability to see the future, it is of course impossible to exactly anticipate such events. However portfolios can be positioned in a more advantageous way to deal with volatility if and when it does materialise – irrespective of central bank activity! Active management is critical here. Passive strategies, which have benefitted more than most from benign conditions within fixed income can often struggle with volatility. As rates have continuously moved lower, duration risk has continued to build in line with the lengthening of the average maturity profile of corporate and sovereign debt. The impact of any sudden widening in spreads/yields can therefore be magnified. Not only can drawdowns be deeper but it can also take longer to recover losses due to the lower yields on underlying bond investments. Actively managed portfolios on the other hand can be better positioned to handle volatility in terms of avoiding excessive drawdowns and capitalising on volatility. And remember, ultimately higher yields in fixed income are a good thing. Why? Because they mean higher returns! In the end, it is our strongly held view that fundamentals will win out and good companies bought at good prices is the only way generate sustainable returns over the long run.
Steve O’Hanlon, May 2017
The views above are published solely for information purposed and are not to be construed as a solicitation or an offer to buy or sell any securities, or related financial instruments. It does not constitute a personal recommendation as defined by the Financial Conduct Authority (“FCA”) or take into account the particular investment objectives, financial situations or needs of individual investors. The views above are based on public information and sources considered reliable.