Invesco
January 25, 2016
Invesco is an investment management firm that believes in putting investors first.

‘White-knuckle’ investing during volatility: Lesson learned from the Great Recession

This series uses historical economic snapshots to explore how a “stra-tactical” investment approach that combines strategic and tactical allocations can help investors manage volatility. This final blog looks at flows into equity and fixed income markets since the Great Recession. The first blog looked at the bond-unfriendly period during the 1950s and early 1960s, while Part 2 examined the bull equity markets of the 1980s and 1990s.

It’s a market truism that investors are prone to making the wrong decision at the wrong time, thus subjecting themselves to a white-knuckle ride that churns both portfolios and stomachs. When you follow the money, that certainly appears to have been the case after the Great Recession.

Following post-crisis flows

Understandably rattled by record equity losses in 2008, investors decamped into cash or fixed income instruments. Flows into fixed income instruments surged from 2009 through 2012 — despite historically low interest rates and bond yields — and then the asset class delivered negative returns in 2013. Not surprisingly, net flows into equities flattened during the same period. Although equity flows didn’t turn decidedly positive until 2013 — when the S&P 500 Index returned more than 32% 1 — equity markets have enjoyed a secular bull market for much of the last six years. After the financial crisis, markets turned sharply, with the S&P 500 Index rising a cumulative 248% through Dec. 31, 2015, since the low on March 9, 2009. 2

More recently, as the probability of a Federal Reserve (Fed) rate hike increased over last summer, we saw that investors soured on fixed income, which saw net outflows from June through September 2015 as investors sought to avoid losses from the impending rate increase. But remember what actually happened:

  • The US and global economy paused.
  • Equity markets sold off sharply in August and September.
  • The Fed didn’t increase rates as soon as expected.
  • Risk aversion took hold.

As a result, investment grade fixed income was the only asset class with gains in the third quarter.

True, investors who fled fixed income may have felt vindicated in the fourth quarter, when credit sold off — driven primarily by lower-quality credits fueled by the ongoing disruption in the energy markets — and liquidity concerns triggered by the closure of a distressed debt fund in December. This resulted in losses of 1% or less for most fixed income indexes during the quarter, while high yield was down approximately 2%, 3 according to the Barclays US Corporate High Yield Index.

However, 2016 has ushered in a new “risk off” trade, with equities and other risk assets selling off significantly, while high-quality fixed income has remained relatively stable. It has been quite a roller coaster ride over the past six months, precisely the type of environment that leads investors to make rash decisions.

Market timing is like lane changing

With the benefit of 20/20 hindsight, we see that investors who try to time the market have historically moved into and out of assets classes at precisely the wrong time. An apt analogy is maneuvering your way into a faster lane in a traffic jam, only to find yourself with a white-knuckle grip on the steering wheel when your lane unexpectedly slows down. (My colleague Tracy Fielder commented on this in his blog Diversification: A better way to avoid portfolio gridlock.)

Specifically, many investors swerved out of stocks, missing out on equity gains for years, while collecting extremely low coupons from their fixed income portfolios — rates on the 10-year Treasury, currently near 2%, have ranged between 2% and 3% for the better part of the period from 2012 through 2015. 3 Then, with memories of 2008 and 2009 fading somewhat, bullish investors decided to get back into the equity lane, only to be caught off guard in the recent selloff. These portfolio lane changes resulted in missed growth opportunities after the March 2009 low and may have resulted in real losses, as investors reduced allocations to assets that may have cushioned their portfolios during the recent selloff. Wrong place, wrong time, white knuckles, yet again.

A white-knuckle alternative

Fortunately, investors, unlike drivers, don’t have to pick just one lane. Instead, we can diversify our portfolios with a stra-tactical approach to investing — one that affords the flexibility to tactically pursue specific investment opportunities without going all-in or all-out of an asset class. Such an approach can help smooth the bumpy ride that causes investors to make the wrong decision at the wrong time.

While no one can predict what the next month or six months may bring, a strong consensus sees volatility continuing for equities and fixed income for the foreseeable future. Investors may therefore want to talk to their advisors about a stra-tactical strategy may potentially help:

  • Prevent one asset class from dominating portfolio performance.
  • Diversify their portfolios to prepare for a variety of economic environments, including rising interest rates.
  • Tactically avoid missing out on opportunities by preparing for market movements that are counter-cyclical.
  • Achieve their financial goals with a balanced exposure to asset classes.

In addition, staying stra-tactical may help investors be in the right place at the right time — with normal-colored knuckles.

1 Source: Lipper, 2013

2 Source: FactSet Research Systems, through Dec. 31, 2015

3 Source: US Department of the Treasury, as of January 2016

Important information

The Barclays US Corporate High Yield Index is an unmanaged index considered representative of fixed-rate, non-investment grade debt.

Risk-off refers to price behavior driven by changes in investor risk tolerance; investors tend toward lower-risk investments when they perceive risk as high.

Past performance is not a guarantee of comparable future results.

Asset allocation/diversification does not guarantee a profit or eliminate the risk of loss.

An investment cannot be made directly in an index.

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.

In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.

Although bonds generally present less short-term risk and volatility than stocks, the bond market is volatile and investing in bond funds involves interest rate risk; as interest rates rise, bond prices usually fall, and vice versa. Bond funds also entail issuer and counterparty credit risk, and the risk of default. Additionally, bond funds generally involve greater inflation risk than stocks.

Marie Jordon

Senior Product Manager

Marie Jordon is a Senior Product Manager for Invesco. She works with Invesco’s Relative Value Equity Teams, the Invesco Convertible Securities Team, and the Invesco International Companies Team to develop sales and marketing programs, position their strategies across distribution channels globally, and produce timely commentary and insights for investors and financial professionals.

Ms. Jordon joined Invesco in 1999 in the retail distribution channel. From 2002-2009 she worked as an investment services analyst working with Invesco’s subadvised, offshore and institutional clients. In 2009, she assumed her role as product manager. Ms. Jordon earned a B.B.A. in Marketing from Texas A&M University in College Station. She holds the Series 7 and 66 registrations.

 

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