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Advisors: help investors understand the value of asset allocation, strategic risk allocation and diversification in volatile environments.
The economy. Trade wars. Elections. There’s no shortage of uncertainty for investors. While diversification is always valuable, it’s especially useful when there’s heightened uncertainty and volatility. You can never tell what security, sector, country or asset class might be affected by an unexpected event. The more diversified the portfolio, the better prepared investors are against unforeseen risks.
How investors can approach uncertainty and volatility
- Distinguish types of portfolio risk. Understand how they may move in tandem or amplify each other.
For many investors, equity exposure is the most significant driver of volatility. It’s important to think about the types of investments that behave in a highly correlated fashion with equity (or with each other generally). The goal of asset allocation is to be sure that risks are spread out and to avoid unintended concentrations.
- Make sure that you have a strategic policy portfolio in place.
Having a strategic policy portfolio (a baseline mix of asset class exposures) allows a strong foundation. It will be different for every investor, depending on their risk profile and constraints.
- Don’t be tempted to abandon diversification in uncertain environments.
It’s tempting to move to a “safe” asset like cash because for many of us, the prospect of loss drives our decision-making. In many cases, a better approach is to build a resilient strategic portfolio that can help manage risks on the downside. A significant reallocation because of short-term uncertainty rarely pays off in the long term. Instead, consider making tilts when you have high conviction views.
- Make sure you get “paid” an extra premium for taking risk in uncertain environments.
If you're not getting paid for risk, it doesn’t make sense to take that risk. If you don’t have a high conviction view on the market, rely on the allocations in your strategic portfolio and remain cautious.
- Identify portfolio sensitivities, especially during an election year.
Election years are always unpredictable. Some sectors, such as health care or defense, can be dramatically affected by political decisions. If there’s a high degree of uncertainty in a specific area, don’t take a risk in that area, especially if there’s not an obvious risk premium or additional yield.