A Strategy For Managing Market Volatility by Jane Leung, CFA, BlackRock
With market volatility as the new normal for investors today, there is one strategy Jane Leung would like to highlight for investors who are ready to stay the course.
In the midst of market ups-and-downs, it can be difficult to know where and how to be invested. With each sudden movement, the urge to take a deeper dive (or withdraw entirely) can be overwhelming. My colleague Heather Pelant urges you to focus on the long term. Other potential solutions: further diversification and risk management. No matter where you choose to focus, it all needs to be within the context of a well-constructed portfolio.
Adding to Your Basic Portfolio Building Blocks
When constructing a portfolio to achieve your financial goals, there are many choices out there. Most investors are familiar with building blocks like individual stocks and bonds, mutual funds and exchange traded funds (ETFs). Each one serves its own purpose and are all important types of tools to consider as the foundation of your portfolio. How you blend these tools—your asset allocation—is crucial. I’d like to highlight a way to potentially take your strategy a step further for these volatile times.
Today’s Volatile Market Environment
It’s no surprise that volatility is expected to be a semi-permanent fixture in the markets for the forseeable future. Take a look at volatility over the last decade and over the past year:
What this chart doesn’t show is that, whether we like it or not, emotions tend to drive many investment decisions and this often causes investors to buy high and sell low, which is the very opposite that we need to be doing. Sadly, this often results in lackluster performance. It may be surprising, but the reality is that the “average” investor tended to underperform major asset classes such as U.S. stocks and bonds, as well as the common 60/40 blend by a significant amount, ranging from about half as much as bonds and over 3 times less than stocks. With volatility as the “new normal” today, investors who understand the importance of staying the course have been looking for tools to help them better navigate this landscape.
Applying Index Strategies for Minimizing Volatility
Over the past decade, investors have become increasingly more familiar with index strategies, particularly in ETF form, as these tools provide diversified exposure to many traditional broad asset classes such as U.S. large cap, international small cap, as well as specific country or sector exposures. Today there are also index strategies to help individual investors manage portfolio risk, just like large institutions have been doing for decades. The case in point for our purposes: seeking to reduce the impact of market volatility in an investment portfolio.
Adopting a minimum volatility approach may help mitigate losses when markets take a turn, while still being able to participate in the markets when they are moving up. If we look at index strategies for minimizing volatility, specifically the iShares MSCI USA Minimum Volatility ETF (USMV), the iShares MSCI Emerging Markets Minimum Volatility ETF (EEMV) and the iShares MSCI EAFE Minimum Volatility ETF (EFAV), we can switch out equity exposures accordingly, depending on your view of volatility in these areas.
Sample Portfolio Replacing Equity Exposures with Minimum Volatility Strategies
Investors today now have a wide variety of tools to consider when building their portfolios, including minimum volatility building blocks, new tools for new markets. Of course, when selecting a strategy, it’s important to consider your current asset allocation and your long term goals.
Jane Leung is an iShares Asset Allocation Strategist for BlackRock.