In an increasingly volatile stock market scenario, Dan Kemp, CIO of EMEA - Morningstar Investment Management, offers a perspective on volatility. With practical suggestions on how to navigate your way through it.
Does volatility mean that an investor’s portfolio is experiencing more risk?
No.
Volatility is a statistical measure, it’s not what we think about when we think about risk.
Volatility is particularly important if you are drawing an income from your investments after time. But it’s not the main measure of risk. The main measure of risk is permanent loss of capital. Risk of a permanent loss is a function of valuation, fundamentals and behaviour.
It is money going somewhere where you are never going to get it back. Volatility tends to be that sort of shorter-term measure. You get caught by volatility. But really if you are a long-term investor, saving for your long-term retirement, then you need to embrace volatility because that’s when the real opportunities come along. Volatility allows you to buy things cheaply and that’s what we all want to do in investment.
What practical tips do you suggest when dealing with volatility?
- Make sure that your portfolio is at the right level of risk for you.
- Don’t try and time the market. Very few people, if anyone, can do it. If you are buying over a long period of time regularly, and it is part of your routine, then that’s the best way of investing.
- Periods of market turbulence can be especially dangerous for investors as they tend to elicit an emotional response and heighten the behavioral biases to which we are all prone. Left unchecked, these biases can lead to us making poor decisions which can harm long-term investment returns.
- Maintain a long-term perspective to enable you to look through volatility. You need to be able to cope with day-to-day volatility to stay invested for the long term.
- Remember that investment is a long-term pursuit and put all recent price movements in this context. While a sudden market fall may induce panic, it means little in the context of a 10 or 15-year investment horizon.
- Try to avoid the sensational headlines that can lure you into action. It's normally better to read books than listen to forecasts.
- If you are going to look for opportunities, ensure that you have a robust framework for setting the real value of assets. This will provide an anchor for your expectations and help you avoid overreacting to short-term price movements.
- Remember that investors tend to make too many decisions rather than too few. So, if in doubt, do nothing.
What is the lens through which one must view stock bargains?
Market commentators seek to make headlines by making bold predictions about the year ahead. We don’t have a crystal ball at Morningstar Investment Management and are suspicious of stories that neatly fit recent market movements. This encourages behavioural biases that lead to poor investment decisions.
We view investing through a valuation-driven lens; we focus on identifying assets that appear to be priced differently to a reasonable expectation of the long-term return.
- A discount is not the same as a bargain. Don’t buy something because it is unusually cheap. A discount on the previous price does not necessarily mean something is desirable. In the investment context, shares may be cheaper than they were but may not offer good value.
- Shoppers know that the best bargains appear when something becomes unpopular and the seller wants to get rid of it to make way for the latest fashion or fad. In investing terms, this will translate into some asset classes being more attractive than another. For instance, currently investors seem more focused on the downside of Brexit rather than the long-term opportunities offered by underlying companies.
- Discounts are never a one-time event. Capital markets don’t have closing down sales. As a long-term investor you never have to pay more than an asset is worth. You will always have the opportunity to buy it at a more attractive price. Just think independently. Focus on fundamentals. Pick bargains that others overlook.
