Building a managed portfolio for all seasons

Market volatility is a reality for all investors. But how do advisers build a managed portfolio solution that can weather both normal and abnormal markets?

Just as the leaves will fall in autumn, and the beaches will be packed in summer, market volatility is likely to be on the horizon. We have seen how markets can be impacted at the hands of an errant tweet by a global leader, swerving sentiment or even a mere ASX announcement. If your portfolios include only one investment approach, investors might suddenly be exposed to the worst impacts of the market’s forces.

For investors, managing through market swings is crucial, in the same way an umbrella is on a rainy day. To do so effectively requires investment strategies that can balance these forces and respond to changing market dynamics.

Fundamentally, this is what investors both want and need; managed portfolios that can comfortably ride out the storm but are also able to take advantage of sunshine and grow when the time is right, effectively positioned as markets rotate through cycles.

Handling market cyclones

The challenges in managing these rotations are best illustrated by looking at how the market behaved from late-2019. Two years ago, we were effectively experiencing the extension of the longest bull run in history. Investing looked easy to many. Passive strategies were increasingly favoured by investors – seen as a cost-effective way to participate in consecutive years of double-digit returns delivered in U.S. and international equity markets.

However, these strategies were not reflective of the fundamentals playing out in the market at the time. U.S. mega caps and tech companies rallied to new highs as the weight of money in passive positions automatically directed more and more investment into the largest growth stocks.

Then in 2020, the COVID-19-induced global health pandemic arrived, with economies grinding to a halt as borders suddenly slammed shut. A mini rotation within equity markets quickly emerged, with a shift towards stay-at-home stocks, including tech titans such as Zoom and Netflix.

Yet the catalyst for a more significant rotation emerged in late-2020 when vaccines combatting the pandemic were introduced. Positive news from the successful trials of three vaccines – and their subsequent approvals – spurred positive investor sentiment, with markets embracing the idea of the global economy re-opening.

At this point, there was a big shift away from the stay-at-home theme and toward sectors that would benefit from a more open economy. Recognising the factors shaping the market, investors began to reinvest their profits into companies whose fundamentals were more rational, driving a shift from growth to value stocks.

Markets turn fast. Throughout the recent volatility, active investing has again demonstrated the benefits from stock selection and savvy diversification has demonstrated its value by intelligently managing the downside in a way that passive strategies cannot match.

A blended approach

Managed accounts – which continue to grow in popularity – are often built with a high allocation to passive strategies, which can limit the overall portfolio’s effectiveness in managing market rotations.

Adding a blend of active and factor on top of passive strategies allows investors to reap the benefits of each: Purposeful security selection through active management, with an added ability to manage risks through the cycle using factor investing.

A blended approach also helps advisers articulate the benefits of the strategies to their clients by being clear about the role of each component in the managed portfolio. Just like a football team in winter, or a cricket team in summer, each position has a unique role to play. To compete effectively, team selection requires the right balance. Advisers can use this analogy to explain to clients how the different components of a blended managed portfolio need to complement each other if the portfolio is to succeed in both normal and abnormal markets.

The sweet spot

Of course, like many things, costs matter. However, it should not be at the expense of including return-seeking or risk-control investment strategies. Passive strategies appeal because they are relatively cheap.

But what we have seen in the market experiences of the 2019 and 2020 market rotations is that low-cost managed portfolios are like cheap umbrellas – when conditions are right, they may work for some time. But when the environment is difficult, they can struggle to perform.

One of the key benefits of having a blended approach to managed portfolios is that it allows advisers to manage costs on behalf of their clients, without sacrificing the benefits of active management and factor investing. This approach helps advisers find the sweet spot for their clients by delivering dynamically managed portfolios at an attractive price point that can deal with market conditions – no matter the season.

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