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Investment professionals often speak of volatility as a bad thing, a thing that is best managed, and a potential problem for investors’ portfolios.
Yet the term describing the markets’ ups and downs, their peaks and troughs — or, perhaps more aptly, the sentiments of greed and fear — is indeed a double-edged sword.
Certainly, volatility can cut deeply. At its highest points, meaning really the markets’ deepest declines from peak to trough, investors of all stripes feel a lot of fear and financial pain. That’s what happened this past March when the S&P 500 — the world’s largest index — fell 35 per cent in a matter of weeks.
And near the end of the steep decline is when one of the main measures of volatility — the VIX (Chicago Board Options Exchange’s CBOE Volatility Index) — peaked.
"Although volatility has come down quite a bit, it is still elevated from a longer-term average perspective," says Shailesh Kshatriya, director, investment strategies at Russell Investments, about the current VIX measure.
Even despite seemingly daily rising markets, the VIX is still higher than it has been for the last several years, he adds.
Its last major spike, by the way, was the 2008/2009 crash, in which it reached record highs — albeit while markets were plumbing historic lows.
For the foreseeable future it appears markets may remain volatile. But exactly what does that mean for average investors, and should they take steps to protect their money against this perceived risk?
The investment industry has plenty of low-volatility products as portfolio salves for nervous investors that have been rolled out over the past decade — which happened to be an extended period of low volatility.
Their performance is mixed depending on the index they aim to tame. For example, BMO’s Low Volatility Canadian Equity ETF (exchange traded fund) gained 101 per cent since late 2011 until recently while the TSX Composite Index — our broadest, largest basket of stocks — only rose about 25 per cent.
But its U.S. market counterpart — the BMO Low Volatility US Equity ETF — largely underperformed its broad-based benchmark, the S&P 500.
More recently these products offered lacklustre performance during the spate of high volatility in March.
"Some of that has got to do with the nature of low-volatility ETFs," says Alan Fustey, portfolio manager with Adaptive ETF in Winnipeg, a division of Bellwether Investment Management Inc.
Low-volatility funds’ core holdings are often real estate trusts, utilities and other stable producers of dividends, and they "got clipped," he adds.
That said, everything went down in March — even bonds.
"What we saw in that period was an unusual spike in volatility," says Michael Cooke, head of the exchange traded funds at Mackenzie Investments.
"And so some of the tools we used in the past to manage it didn’t necessarily live up to that role in the short term."
Bonds are typically protection against downside stock market risk. They are supposed to make the valleys seem less deadly to portfolio dollars. But they didn’t perform that way at the height of pandemic fear frenzy, when all assets were negatively affected.
"All markets really depend on certainty and tend to not do well in the absence of it — like oxygen for people," he says.
"If you take it away, it makes market participants very, very anxious."
Investors collectively tend to sell off everything and ask questions later, he adds.
Since then, markets have rebounded tremendously with many posting record-breaking second-quarter performances, including the S&P 500 up about 20 per cent in three months. That’s its best quarterly gain since 1998. But taken in context of the ups and downs this year so far, the world’s largest stock market index was still down four per cent on the year.
Looking through the rear-view mirror, it’s tempting to think volatility also presents opportunity to buy low and sell high. In truth it does. But putting this strategy into action is easy to talk about in retrospect.
Most individuals do the opposite when asset prices are crumbling around them, Cooke explains.
"Volatility inclines investors to make ill-advised decisions," he says. "If you sold into the volatility unfolding into the February and March period, you were probably selling into weakness sustaining a loss for your portfolio."
Even when you do sell high, and avoid the downside, the challenge remains: You need to buy back into the market.
"If you sell, the only way you make money is if you buy back what you sold at a lower price," Fustey says. That entails buying into a market rained upon by bad news.
Trying to time the market in the last round of deep volatility likely left most people "whipsawed," says Kshatriya. And many likely missed the window for profiting off plunging prices.
In part that’s because few could have predicted the market rebounding as quickly as it has — thanks to fiscal (government stimulus) and monetary (central banks) policies aimed at propping up asset prices (mainly stocks).
"There is no alternative, in a sense," he says of stocks and their recent rally. "Relative to bonds, equities are still quite attractive."
That’s why stocks are recovering, seemingly ahead of the economy — which is still struggling with the impact of the pandemic.
And don’t be surprised by more volatility, or more aptly, downside risk.
Then again, who knows?
As Kshatriya points out, referring to the famous saying of economist John Maynard Keynes — who created the road map used today to revive flatlining economies by pumping money into the system: "The markets can remain irrational longer than you can remain solvent."
As such, the best advice — most experts agree — is to ignore the downs, have faith in the ups, and remain invested in a well diversified portfolio.
If the swings are too much, the calm market days of summer may be ideal to making changes, Cooke adds.
"If you feel the need to make adjustments to your portfolio because your tolerance for risk has changed, it’s probably not best to do that in the middle of a storm."
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