17th March 2020

Reducing volatility in portfolios

The portfolios managed by Spuerkeess under the ActivMandate discretionary management service have proven fairly resistant to the recent high price volatility seen on the financial markets, and have been able to limit the losses caused by collapsing share prices. In this article we will show that this performance was achieved by using highly traditional approaches: the fundamental approach on the one hand, and diversification on the other.

The sharp fall in the financial markets, reflecting uncertainty about the macro- and micro-economic impact of worldwide government efforts to halt the spread of the coronavirus, has led to heightened volatility and a significant fall in the performance of many portfolios. Losses are often significant, comparable or worse than those seen during the greatest financial and economic crises of past years.

Because price movements on the financial markets are utterly unpredictable, portfolio managers are unable to avoid volatility through market timing, which refers to a properly-timed purchase or sale of securities just before price fluctuations occur.

There are other ways to limit portfolio volatility, specifically methods based on a fundamental economic approach, and methods based on classic portfolio theory, which emphasises diversification.

The fundamental economic approach can be used to structure portfolios based on expected economic developments. Economic forecasts are used to locate the current situation on the business cycle curve and, based on that location and forecasts, to modify the portfolio structure by adjusting either the volume of cash or money market instruments, or the portfolio’s sectoral and industrial diversification, modifying the ratio between securities sensitive to the economic cycle and securities with low sensitivity to the cycle.

Yet diversification among asset types, particularly between stocks and bonds, is the most effective way of reducing portfolio volatility according to modern portfolio theory. That is why it is important to prepare a risk profile for each investor, to be reflected through a stock/bond distribution that best suits the profile. At Spuerkeess, these portfolios are represented within the ActivMandate mandate through a range of structures with proven stability over previous years. For example, an investment in ActivMandate Equilibré, composed of 40% stocks and 60% bonds, posted a five-year return of 7,66% as at 11 March 2020, despite the turbulent market environment in 2018 and the turmoil since the start of the current year.