Why a dynamic multi-asset approach matters during volatile markets

We didn’t know 5 February would be the day. No one did. But for the past year, we’ve espoused the benefits of managing risk, rather than taking risk. 

On that day, the Dow Jones Industrial Average plunged 1,175 points,1 marking an exceptionally volatile day for financial markets around the world. The 4.6% drop was the biggest decline since August 2011, and caught many market participants by surprise.

Our stance spoke to the valuations within markets as well as low starting yields in bonds, but was also driven by what we saw as a more seminal aspect to managing risk. In a previous blog post, we discussed that protecting against the downside in markets just may get you more bang for your buck. While the power of compounding through losing less on the downside is relatively easy to understand in theory, to execute that strategy means being willing to reduce risk as markets move higher than your expectations—and doing so in a robust way. Put another way, the time to prepare for a perfect storm is not when the wind is tearing the roof off your house, but before the storm hits.

So how do you prepare?

We’re a multi-asset shop, so we may be biased. But we take our approach because we believe it’s ideally suited for our uncertain times.

While the objectives of multi-asset strategies may vary, our portfolio management team talks a lot about giving clients the returns they require at a risk level they can survive.

A multi-asset approach may help achieve these goals through three main processes:

  1. The design process, where we establish strategic positioning
  2. The construct process, where manager selection and strategic factor positioning takes place
  3. The manage process, where tactical tilts, through dynamic management, help exploit near-term opportunities and avoid uncompensated risks

I’d like to focus on the manage process. Dynamic asset allocation can include managing a portfolio of physical securities, such as stocks or bonds, or implementing overlay-based strategies—including, but not limited to, options, currency forwards and futures. And dynamic is the keyword right now, because we believe nimbleness and dynamism are most beneficial during periods of market dislocation, where the elapsed time between idea and implementation is critical. Because, as 5 February reminds us, markets don’t work on quarterly cycles.

As clients know, guided by our Cycle, Value, Sentiment process, we have been expecting a return of volatility as sentiment, in particular, has been stretched this year. In preparation for such an event, we have at the margin implemented a number of defensive trades, in addition to our relatively cautious equity weighting.

Tactical Trades in our Multi-Asset Growth Strategies ahead of the market downturn:

  • We used call options to gain upside to the UK market without risking any more than a very small amount of call premium (approximately 0.05%)
  • We added Japanese yen to the portfolio, to benefit from its defensive properties (it rallied 2% overnight on the 5 February)
  • We added the Russell Investments value conscious currency strategy to the portfolio
  • We added 5-Year US government bonds to the portfolio

All these trades were additive when markets precipitously fell.

Today we stand ready, at least in the short term, to reduce our long volatility strategy which has rallied hard over the last few days, as we expect markets to recover. Further action may be taken upon opportunity. Having a robust process allows us to rationally analyse the impacts of market moves like this one, asking ourselves the questions, ‘has it changed the outlook for the cycle? Have valuations changed? Has sentiment moved to fear?’ and act accordingly.

As recent events show, the ever-evolving manage process of our multi-asset investing approach enables us to prepare our portfolios for uncertain markets—and dynamically adjust as the cycle, valuation and sentiment in markets evolve. If the recent uptick in volatility is a sign of things to come, we believe that having this dynamic ability will continue to prove essential going forward. Because another correction day will come. And no one knows when.