constant is change”, “the future will surprise” and “investments should never
be based on forecasts”. These phrases attempt to describe the world we live in.
Brexit was a
prime example of how the opinion pollsters got it wrong in the UK. And this was
followed in quick succession by the pollsters getting it wrong again in the US
presidential election. Both these events impacted global bond and equity
markets, as well as exchange rates. What’s more, we have a number of
significant elections and referendums coming up in Europe in 2017, including
the Dutch general election (March) the French presidential election (April/May)
and the German federal election (September). With multiculturalism dominating
the debate, there is the potential for additional electoral surprises and
uncertainty and volatility keep many investors up at night. But in times like
these, it is always worth reminding ourselves of the two key aspects of
Managing our investments – The strategic and tactical
measures taken to invest in a variety of assets in order to produce long-term
returns in line with one’s goals; and
Managing our behaviour – The way investors react to a
changing investment environment and the decisions they make. Significantly,
there is much evidence to suggest that investors are not always as rational as
they think they are!
One of the
biggest destroyers of wealth is not the markets, but rather the way in which
investors behave during times of uncertainty. While we cannot control
investment markets, we can certainly control how we react to them.
the question of how investors deal with this uncertainty and the resulting
market volatility. The answer is relatively simple. Rather than getting carried
away, along with all the news channels and “experts” commenting on these
markets, it starts with diligent financial planning and, to borrow from Rudyard
Kipling, to “keep your head when all about you are losing theirs”.
a financial plan that is designed to adapt to volatile markets, implementing it
and then actively reviewing but not deviating from that plan midstream,
investors can dynamically match their assets and anticipated drawing
requirements, thus managing the two critical risks they face, namely volatility
correctly, an investor’s exposure to volatility risk can be reduced by
including a pool of funds (within a well-diversified portfolio of local and
global assets) that is not exposed to market volatility or the exchange rate to
provide for their short- and medium-term monthly needs.
strategy incorporating a non-volatile pool of funds reduces the risk of
short-term volatility, it unfortunately does not solve the objective of
protecting the purchasing power of an investor’s hard-earned savings. It also
means that assets that have come under volatility pressure do not have to be
sold to provide for immediate income needs. In this way you can protect the
growth portion of the portfolio. One of the drawbacks of holding traditional
mixed asset type unit trust funds (e.g. balanced funds) is that while they
include these non-volatile assets, in drawing from them the fund sells across
all asset classes regardless. This does not protect the growth assets.
against inflation, investors need to embrace the opportunities that arise from
volatile markets. Therefore, investors will require a second pool of funds
through which they can protect the purchasing power of their savings by
investing in asset classes that can reliably outpace inflation over time. These
growth assets, such as inflation-linked bonds, hedge funds, property and
equities, combined in local and global portfolios, will protect investors
these investments are inherently volatile and, in order to realise the growth
potential, investors need to stay in these markets despite the volatility. This
is where investors’ behaviour (response) is critical.
a well-constructed financial plan, investors will know when they will need
money from the different fund pools and this gives their asset management team
a clear mandate to manage volatility – both as a risk in the short term and to
embrace the opportunities it provides to outperform inflation in the longer
term with an inflation-plus strategy. In the end volatility is not risk; it is,
well, just volatility.
investment principles remain constant, technological breakthroughs and ongoing
research enable investment managers to discover additional key principles of
wealth management. When better ways of managing money and risks are uncovered
and proven to work, it is desirable to adopt those practices leading to
enhanced wealth management. This will ultimately ensure that portfolios have
the highest probability of achieving investment goals within acceptable levels
of risk, in accordance with a financial plan.
Nic Horn is a certified financial planner and regional head at Citadel.
This article originally appeared in the 9
February edition of finweek. Buy
and download the magazine here.