The landscape for investors rapidly changed over the past few years. Volatility has reigned in the markets since the crisis of 2008. Traditional investment methodology, such as investing in a portfolio of blue chip stocks, may no longer prove successful. The speed at which technology increases the flow of information across the capital markets increases the likelihood of market volatility. These “flash” crashes and other irrational market behavior are not based on valuation but rather on the reaction of markets to information, positive or negative. The bond market has been also been challenged by the environment of low interest rates for some years. Bonds were once viewed as a possible haven for capital stability and reasonable income. The forecast for interest rates remaining low challenges the bond investor to seek acceptable income and puts a cloud over existing fixed income investments if interest rates do rise.
Traditional solutions to volatility would include diversified portfolios, but even this method has its drawbacks. As markets are becoming more highly correlated, the benefits of diversification, which depend on lower correlation, begin to fade.
So what is an investor to do in this brave new world?
Investors and managers are shifting their focus toward managing volatility rather than generating alpha in portfolios. Typical goals for investing include keeping up with inflation, stabilizing wealth, and achieving a reasonable return commensurate with risk. Many investors are taking a closer look at alternatives such as real asset, tactical, and long/short strategies. Quantitative or rules-based strategies have been viewed by some as a means to counteract the irrationality of markets. Advanced algorithms in these models may be better able to identify trends in price movements and complement the traditional qualitative process.
Investors will be looking beyond the traditional buy and hold methods of the past as they navigate the choppy waters of investing going forward. Whether it’s the tech bubble in the late 1990s or the real estate-led crash in 2008, we are constantly reminded of the necessity to set reasonable expectations and to take an active role in the protection and growth of personal wealth.