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Demystifying how to face down volatility

February 2018

Equities whipsawed in February. While this was unsettling, investors should always resist the urge to take drastic action when markets stumble.  

When stock prices move up and down violently over a short period as they did in the first week of February this year, it’s natural for investors to feel disorientated. After all, the pain of financial loss is felt more deeply than the satisfaction that comes with investment success. 

But experience has shown us that, to invest effectively, we need to control our urge to take evasive action at the first sign of trouble. 

Investors should never forget that the secret to capital growth is compounding – the snowball effect of reinvesting your returns to generate future returns,” explains Shaniel Ramjee, senior investment manager, multi-asset strategies, at Pictet Asset Management. “To benefit from the compounding effect, it is essential that investors maintain a long-term perspective at all times. Making snap decisions in response to one piece of data carries significant risks.”

Indeed, it is when markets are volatile that investors should remind themselves of the principles of effective investing.

Stay diversified. It’s a rule that investors should follow at all times, but maintaining a diverse range of investments during periods of market volatility is not only advisable, it’s necessary. History tells us that diversified portfolios are better able to withstand the negative effects of volatile markets than concentrated ones. 
Fig. 1 Because stocks and bonds behave in different ways, diversification makes sense 

Yearly return, by asset class

demystifying volatility
Source: Pictet Asset Management; data covering period 31.12.2012 - 31.12.2017. All figures quoted in USD. Past performance is not indicative of future returns. Benchmarks used are the MSCI World, S&P 500, Citigroup WGBI All Mats, MSCI Emerging Markets and JPM GBI-EM Global Diversified.
Maintain a long term perspective. In addition to building a diversified portfolio, keeping a long-term perspective is essential when markets stumble. Experience shows that crises and volatility are temporary, and that stocks eventually recover.  
Fig. 2 Severe market declines are rare

Number of months in past 15 years when market has fallen...

volatility number of months
Source: Pictet Asset Management, 2003 – 2017. Figures quoted in USD. Past performance is not indicative of future returns. Benchmark used is the MSCI World.

Staying the course – rather than reacting to short-term shifts in market gauges - can reap rewards over the long run.

Investing regularly helps. Even the most seasoned investment professional finds it difficult, if not impossible, to accurately time the market. That’s why investing regularly in fixed amounts is a potentially better approach to take over the long run. Investors who do this find they buy more shares at lower prices and fewer shares at higher prices.

Bonds aren’t the only answer. When trying to protect a portfolio during times of market stress, many investors gravitate towards bonds, which are valued for their defensive attributes. But they are not the only option. Instead of making wholesale changes to portfolios, investor could consider retaining equities but via group of stocks that have proven to be resilient during periods of high market volatility, such as those represented in the MSCI Low Volatility Index. Other commonly used tools to diversify a portfolio include alternative investments such as property or gold.