Getting Clients Through Volatility Safely
There are a lot of environments that are conducive for investment accounts to succeed by using a traditional asset allocation model. This includes a mix of international & domestic stocks and bonds. This portfolio allocation, however, can put investors at risk if market conditions change and correlations are high. This hard lesson was behind a lot of investor’s pain in 2008. This long bull market has created an environment that is vastly different than the last two years. From the Greek instability and the uncertainty of their future in the Eurozone, rising concerns about China, the strengthening of the US dollar, and the conservative market leadership have all added to this environment where traditional asset diversification strategies may not prove to be ideal.
With any market, client portfolios should have proper diversification to ensure that risk management practices are in place. Portfolios can thrive when uncorrelated and negatively correlated investments are introduced to the portfolio Alternatives play a key role in this asset allocation strategy. This provides the much-needed diversification to client’s portfolios that can completely offset or even eliminate the directional bet placed with traditional asset class correlations increasing. These investments should incorporate strategies that aim to bring positive returns in any market environment—even with low correlation to the traditional indexes—to give a buffer against market turns. There are plenty of options available, but here are the top 3 allocation strategies that deserve special attention on the current market:
Long term allocation volatility strategies
Periods of market turmoil (like the one may be preparing for now) are characterized by significant increases in market volatility. The VIX index (the CBOE Volatility Index) reflects the market’s estimate of future instability. Investors who want to protect themselves against market downturns could benefit by taking a long term VIX position through futures or even an ETF that tracks the VIX.
Pad Stocks with an inverse economic correlation
If stock indexes plummet, the equities markets can provide some diamonds in the rough. Some stocks can even perform at market highs during these periods of economic instability. Retailers including discount/dollar stores, pawn shops, and auto parts have an inverse economic correlation—when most markets dip, these companies can provide the light at the end of the tunnel, value and growth. For example, Dollar Tree was up 60.8% in 2008. A diversified portfolio allocation using this school of thought may allow investors to retain equity exposure while also position their portfolio more effectively if the economy tanks.
Managed-futures funds & strategies
Managed futures allocation strategies take both long and short positions in futures options, swaps, and foreign exchange contracts. This plan of action employs following trends, price momentum, systematic mean reversion, discretionary global macro strategies, and commodity index tracking and other futures strategies.
There is a ton of speculation currently filling the marketplace, and it can be hard to sort through all the options to paint a picture of what’s ahead. To help settle fear and uncertainty, you may want to reassess your clients’ portfolio allocation to ensures that proper emphasis is placed on strategies that are designed to ride through the market as it ebbs and flows.