Investment strategies in uncertain times

Uncertainty and periods of volatility are an expected part of life as well as financial markets and investors should be considering how to factor these into their investment strategies. While there’s no easy fix strategy that can be used for all investors, effective strategies tend to share a few aspects in common.

We discussed investment strategies for uncertain times with Andrew Connors, Founder and Director of Quilla, one of Australia’s leading independent investment consultants serving financial advisers and institutional investors.

The characteristics of a good investment strategy

A good strategy will be tailored to the individual investor’s needs, goals and circumstances but there are a few aspects that should hold true regardless.

“You can’t avoid diversification. It’s still the only free lunch you get with investing, and what I mean by that is you can invest in two securities that, in combination, mitigate some of the risks of each of those securities individually, without necessarily impacting the return,” 

Mr Connors notes that diversification is more than just holding a variety of shares, it’s avoiding a concentration in one sector, region or asset class. Australian investors tend to have a home country bias where they mainly hold assets listed on the Australian stock exchange rather than spreading investments internationally and across assets.

“Another characteristic of a good strategy would be to manage excessive turnover in your portfolio. Turnover is one of those things that chips away at your returns in the background. So being aware of the impact of transacting and the transaction costs is important for a good investment strategy.”

Understanding the products you are invested in, the risks involved and any correlation between your investments is also valuable to setting an investment strategy. For example, knowing that the performance of two particular assets is positively related may reduce the diversification benefits of both. Or alternatively, only investing in high risk investments may mean you are more exposed to volatility than you would like to be.

Mr Connors also believes that investors should be aware of liquidity in their portfolios.

“Liquidity was certainly impacted during the period of March when we saw the majority of the market falls… Being able to get your money out when you want it is an important characteristic of a portfolio, but also understanding those assets that don't necessarily have that liquidity. It's not necessarily a bad thing, but you need to be aware of it so that you are not surprised when we go through periods like that,” 

Adjusting in periods of uncertainty

Mr Connors has sought to incorporate investments that might perform differently to financial markets or offer stability to hedge riskier assets in the portfolios he recommends.

“Cash is an asset you shouldn't be afraid to hold in your portfolio to protect wealth, and that's especially important in this current market environment given the swings we've seen in shares. Related to cash, but with slightly more risk, is bonds or bond funds. These still have a place in your portfolio, even when yields are so low, but you've got to understand they're not risk-free assets,”

In the current environment, Mr Connors has also seen value in foreign currencies and precious metals to support investment portfolios.

“Foreign currency exposure… can insulate some of that volatility that we see from holding shares in your portfolio,”

Investors can incorporate such exposure by using unhedged international investments or by taking a direct currency exposure. This could be by transferring cash into other currencies or using ETFs like ETFS Enhanced USD Cash ETF (ASX:ZUSD) for exposure.

In terms of precious metals, gold has been a focus for Mr Connors.

“Gold's been something we've used in portfolios over the last six to seven months as a tactical hedge against certain risk events… Gold has been up 9% this year to the early part of June, although it did experience some volatility throughout the pullback we saw in March.”

Mr Connors uses a blend of actively managed and passively managed investments in his portfolio, with active credit managers gaining in recent times. The liquidity and ease of use of ETFs has been valuable during the past few months.

“The specific benefits of ETFs, for us, include being able to use the ASX clearing house. So that means that we can implement complex transactions with multiple buys and sells, and that they all can be executed at exactly the same time. And that's a really important point, that speedier execution, especially in times of heightened volatility when the markets are going up or down by 7% in a day. So you don't want to be out of the market in that type of environment. So that's certainly an advantage compared to the slower process utilised when you're buying or selling managed funds,”

On the horizon for markets: time to invest or time to exit?

Mr Connors considers the strong recovery in prices since March concerning and not reflected by the fundamentals in companies globally.

“We're still seeing the Coronavirus as not being under control, even though investors seem to have already priced in a recovery. We're also concerned about the impact of the geopolitical conflict between China and the US, and its allies, for that matter, like Australia. So that has the added potential to disrupt the fragile recovery that's underway in the US. And that would certainly add further pressure to the rally in equities that we've seen over recent months as well.”

He suggests investors go back to the basics of portfolio construction and focus on the long term, considering measures like dollar-cost averaging (i.e. consistent investing over time) as part of their strategy.

“Don't expect to get the results you want in too short a time frame. You've got to let these things play out, and… complement that good investment philosophy and that good investment strategy, with an approach that perhaps sees you gradually entering back into the market,”

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