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Message for investors: why volatility may be here to stay

Written by: Darius McDermott
Hillary's had pneumonia, Donald's gained in some polls, traders are back from their summer breaks and there are rumours of a pre-election rate rise from the US Federal Reserve next week. It's little wonder volatility has come back into markets.

Our own stock market has had a pretty decent run since the Brexit vote, without any other major global events to upset things. And broadly speaking, apart from a few dips and bumps, volatility has been relatively suppressed over the last few years – largely as a result of the amount of stimulus central banks have pumped into the economy.

But this ‘complacency’ in markets may be changing. Three key central banks are affecting the mood:

  • The US Federal Reserve (the Fed) are not the only ones due to meet this week. The Bank of Japan (BoJ) will also convene. The country has had a rough couple of decades and the BoJ have been at the forefront of experimentation when it comes to using ‘monetary policy’ (essentially lowering rates and buying bonds) to try to boost economic growth. The problem is these efforts haven’t really worked and now, in the lead up to their next policy decision, both the BoJ governor Haruhiko Kuroda and his deputy appear to be preparing to potentially change tack. What will be next no-one can say, but given the Japanese bond market is one of the largest in the world, any changes will have global ripples.
  • The European Central Bank (ECB), meanwhile, met earlier this month. Like Japan, Europe has struggled to really get its economy going since the global financial crisis and key health indicators such as inflation and unemployment continue to move in the wrong directions. And like the BoJ, the ECB has trialled zero and negative interest rates and bond buying to generate economic growth – again, to not much effect. So in March this year ECB president Mario Draghi announced a raft of additional stimulus measures, which began in June. At their latest meeting, many expected even more to come. But Draghi held fire, leaving investors guessing as to whether the ECB, too, feels it has gone as far as it can down its current path.
  • And then, the most anticipated of them all – the Fed. As the largest economy in the world, the US’s decisions affect everyone. After seven years of zero interest rates, it raised its rate just a quarter of a percent at the end of last year. This was probably a delayed signal that the US economy was finally doing alright and the Fed wanted to start bringing stimulus to an end. But shortly after the global economy was deemed to be at risk, in particular China, and events such as Brexit discouraged the Fed from further increases. It would be highly unusual for them to tinker with rates so close to an election, yet talk has turned to this possibility. If they do follow through, a rate rise will again indicate the Fed want to stop propping up the economy and see if it is strong enough to make it on its own. Stock and bond markets may well disagree, in which case we could see sell-offs across the board.

If you haven’t already, all of this signals a pretty good time to make sure you have some protection in your portfolio. What’s more, given valuations on equities currently historically high, prices are at an increased risk of falling if we do hit a particularly rough patch.

Some funds are designed specifically for this kind of environment, with lower volatility than stock markets while still working to deliver returns above cash for investors.

One of my favourites for portfolio protection is Henderson UK Absolute Return. It has been less than a third as volatile as the UK stock market over the past five years, while still delivering equity-like returns. The way it achieves this is by taking both long and short stock positions – which means it tries to profit both from stocks it thinks will go up in value and stocks that will fall.

Another way to go is to get a fund that holds a mix of assets – so you can still have some equity exposure for growth, but take on less risk. The Premier Multi-Asset Monthly Income is a sturdy choice. It too has demonstrated significantly lower volatility than the UK market, yet it is still managing to deliver an income of around 4.7% – pretty impressive in the current climate. A multi-asset and multi-manager fund, it benefits from diverse expertise and a strong focus on risk management.

Darius McDermott is managing director of Chelsea Financial Services  

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