Asset Management – Embracing short-term volatility

Manty Seligman
Director – Asset Management

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Embracing short-term volatility in creating value

In times of prevailing investment market turbulence, investors need to heed that volatility and uncertainty can present unique opportunities and not just risks.

Crafting a well-thought-through long-term investment portfolio during such periods is not only possible but can be opportunistic, seeing turbulence (which often entails short-term losses) as an advantage and not something to be avoided.  Clearly, this portfolio construction comes with a health warning and requires a fundamental understanding of the various factors at play.  Political turbulence, global conflicts, environmental changes, and socioeconomic trends can all be dominant themes.  Ordinarily avoided, here are some reasons why a more aggressive investor (and this might better be defined as an investor with an appetite for more short-term volatility) would actively seek out these trends as investment opportunities in the creation of a sustainable long-term investment portfolio.

Exploiting mispricing

During times of heightened volatility, asset prices often deviate from their intrinsic values more than at other times, due to market overreactions or panic selling.  This creates opportunities for investors with the appropriate risk appetite to acquire assets at discounted fees, anticipating significant gains as markets normalise.

Capitalising on global events

Political turbulence and global conflicts, such as the Ukrainian-Russian conflict or the Israeli-Palestinian conflict, can have profound implications for financial markets.  Wars often create specific investment opportunities.  The most obvious example would be that it’s a good time to be an arms manufacturer.  Conflicts often create predictable bottlenecks and commodity shortfalls (as seen with the price of Ukrainian wheat and the cost of oil).  These correlations are not always apparent and can seem disassociated with the root cause of the turmoil.  The Ukrainian conflict has shown that global supply chains and the international price of key commodities, far from the battlefields affect the entire world.  Food prices in Africa have escalated, partially as a result of this war.

The very fact that these events often spook investors and trigger market sell-offs, creates the very opportunity that some investors have the appetite for.  By staying informed about geopolitical developments and understanding their specific potential impact on various asset classes, investors can position their portfolios to benefit from market movements driven by global events.  Anticipating future scenarios can reap handsome rewards, and having prior notice of calamitous events, even more so.  Though largely hearsay, Osama bin Laden’s short positions ahead of the 9/11 attacks are an extreme example of taking advantage of some catastrophic event.

Navigating economic uncertainty

Periods of economic uncertainty often follow sudden market turbulence.  Markets take time to assimilate the information and then grapple with the projection of post-turbulent economic growth, inflation, and central bank policies.

In these times, investors who adopt a contrarian approach and maintain a long-term perspective can capitalise on temporary market disruptions, building positions in undervalued assets, and hedging against economic uncertainty by diversifying their portfolios across asset classes that exhibit low correlation with traditional financial markets.

Using socioeconomic trends

Socioeconomic trends, such as demographic shifts, technological advancements, and changes in consumer behavior, can shape the investment landscape over the long term.  The early identification of these emerging trends and investment themes allows astute investors the opportunity to position their portfolios to benefit from these structural changes.  Examples of socioeconomic themes that have profoundly changed investment markets in the recent past can be seen in renewable energy, healthcare innovation, and digital transformation.  The prevailing top six US stocks are all digital companies, have a combined value of some USD 10 trillion and most were not in existence 20 years ago.  Identifying this socioeconomic theme and being an early investor in this sector has defied all normal investment parameter expectations.  Yes, this would have involved some speculation, but a good understanding of a sustainable future trend reaped handsome rewards for investors with the appropriate risk appetite.

Embracing risk and volatility

Prevailing market turbulence almost always induces fear and uncertainty.  Investors need to recognise that risk and volatility are inherent components of investing.  The lower the risk, the lower the potential returns (cash in the bank being a case in point).  By embracing risk and maintaining a disciplined approach to portfolio management, investors can capitalise on short-term market fluctuations while still focussing on sustainable long-term investment objectives.

Moreover, investors with a higher risk tolerance may well see stronger long-term performance, accepting the volatility that the short-term almost certainly delivers.  Investors (or their appointed advisors and fund managers) will need to do more thorough research and investigation than would ordinarily be the case, in diversifying their portfolios into higher-risk environments and will need to remain disciplined in their investment approach as they navigate through turbulent market conditions.