As the US investigates the recent pipe bombs being sent around their country, the authorities are reminding US citizens that “terror only works if you let it work”. At the same time, the stock markets worldwide are more volatile than for a few years and the media reports, although mostly factual, can cause unnecessary alarm – if allowed to do so.
Some of the possible reasons for the volatility include rising interest rates, trade wars, political uncertainty and the slowdown of the Chinese economy. The primary reason is that investor psychology – prices are a function of investors confidence in the future.
As most of our clients know, as prices rose over the last few years we at SentinelWealth have been expecting more volatility and have restructured our portfolios to be as prepared as possible. What’s required now, is a continued implementation of the strategy.
It’s early days, but the changes we made look like they will work well
Over the last two years we moved portfolios more defensively. Greater exposure to cash and bonds has been common and these assets will dampen the volatility of the stock markets. By using floating rate bonds, term deposits and bond funds, we believe we have created the best possible ‘defences’ to the expected volatility.
Ironically, when recommending these changes, many clients expressed concerns about the low interest rates on cash. Our justification always was that low interest would look very good against falling asset prices – and it does. In addition, we regularly observed that many investors were in our view, under-pricing risk whilst chasing returns.
Another significant change has been to active managers and in the Australian stock market exposure, away from banks. In our global portfolios, we moved away from the tech stocks and into managers with a focus on more stable value stocks.
All of these strategies are proving to be good for portfolios on a relative basis and although we may still experience negative returns, they won’t be as bad as they would have been.
The focus now
Prices don’t necessarily reflect the value of an asset. The real value of companies doesn’t change as rapidly as the stock market suggests. The value of the underlying assets hasn’t actually changed – as opposed to the perception.
It’s time to be more focused on the yield. It’s unlikely to change very much and ultimately, it’s the income from assets (the yield) that counts.
We have had a major emphasis on ensuring that the underlying companies owned in the portfolios are of high ‘quality’. Our definition of ‘quality’ in this context is companies with low debt and high, consistent profitability. The assumption is that ‘quality’ companies will not only be better equipped to manage a downturn, but will also be able to take advantage of others more precariously placed.
The portfolios are also well diversified, not only across asset classes but also within each asset class. We have significant exposures to Australian and Global shares but also to bonds and cash. Within each there are sub-asset class and risk factor exposures.
The investor’s behaviour is critical
We expect the volatility to continue and as it does we will continually re-balance portfolios as best we can. It will be equally important for investors to be ‘keep the faith’ in the strategy. This largely means that we need you to:
- Accept that stock market falls are big news for the media but don’t necessarily reflect what’s happening in any specific portfolio,
- Constantly remind yourself to focus on income not price, that you own quality, well-diversified assets and that there is a process in place to monitor and manage your assets.
Our process will also provide indications when to start buying back into the markets and we can be sure that when this happens it is likely to be at a time when negativity is rife. It’s always difficult to buy assets that have done badly for someone else but that’s exactly the best time.
If you have any concerns, please don’t hesitate to contact your adviser.