5 Second-Half Tips For Investors
Rising Rates Aren’t the Only Market-Mover Much of the market’s focus so far in 2015 has been on when the US Federal Reserve (Fed) will raise rates. With the Fed promising to be “data-driven,” each economic release has received more scrutiny than usual. But the decision on rates is not the only driver of markets. Increasingly, events and data outside the US are having an impact on markets here at home, adding to the range of factors that affect investors: 5 Tips for Investors 1. Ensure adequate exposure to risk assets. Many investors with longer time horizons are in jeopardy of being unable to fund their goals because their allocations are over-exposed to cash and core bonds. For long-term goals like retirement or a college education, portfolios need exposure to asset classes that have the potential to deliver growth – which means investors need adequate exposure to stocks. 2. Watch out for interest-rate complacency. At some point, the Fed will begin raising interest rates, and we don’t believe most market participants are prepared for the hike. Equity investors should anticipate some negative short-term reactions in the stock market, but should also keep in mind that equities have historically sustained several rate rises before declining. What’s more, given how low short-term rates currently are, higher rates would be unlikely to constrain economic output and activity which means that any equity-market selloff should be limited. The greater risk of complacency may lie with owners of US treasuries and other core bonds who are anticipating continued lower rates, those investors may be unpleasantly surprised. 3. Be risk-aware. While many investors worry about more obvious risks, such as tail risk (the risk of an asset or portfolio moving more than three standard deviations away from its current price), they may be less aware of other dangerous threats, such as liquidity risk. For example, in a recent Allianz Global Investors survey on risk, we found that 95% of institutional investors believe tail risks pose a medium, high or very high risk of likelihood over the next 12 months, but 40% view liquidity risk as little or no threat. And even though investors worry about tail risk, far fewer believe they are adequately equipped to protect against it: just 27% use strategies that hedge against it. It’s critical for investors to be well-informed about all the risks facing their portfolio and the risk-management tools they have at their disposal. 4. Protect against volatility. We expect increased volatility in both stock and bond markets. This may mean investors should reduce their exposure to fixed income. However, investors shouldn’t abandon stocks because of higher volatility; instead, they should manage that volatility wherever possible. We recommend the use of options strategies and other sophisticated tools, in addition to broad portfolio diversification and exposure to dividend-paying stocks, which have historically offered lower volatility than the overall stock market. 5. Use active management. In this unique and unpredictable market environment, we expect correlations among stocks and among asset classes to fall, creating a more differentiated market environment in which active managers can outperform. In addition, we expect rotations in leadership among different asset classes. Investors might want to consider using an actively managed multi-asset investment that offers broad exposure and can adjust allocations to take advantage of opportunities (including low valuations) and manage risks (including rising rates and geopolitical crises). Strategies like these can also help investors offset behavioral biases and self-inflicted psychological obstacles by providing one professionally managed investment that they can “set and forget.” The Bottom Line In the second half of 2015, investors need to recognize that downside risk has increased for both stocks and bonds. However, if they have long time horizons – and if they use risk-management tools in a well-diversified, actively managed portfolio with adequate exposure to risk assets – then they should be in a much better position to meet their long-term goals.