Quitters never win. Perhaps proper advice for the athlete learning to master a new sport - not so much for the investor learning to master her portfolio.
Recent economic headwinds around the globe have pushed volatility to the forefront of many investors’ minds. That much is made clear when looking at the price of options on the Chicago Boards Options Exchange Volatility Index (VIX) - or, as some know it, the market’s fear meter. According to Bloomberg, call options on the VIX, which gain in value as volatility in the Standard & Poor’s 500 Index rises, spiked in price to levels not seen since 2006, suggesting investors are betting on a bumpy ride ahead.
Ironically, the volatility index has seen its own sharp ups and downs in recent weeks, rising to a high not seen since the beginning of the year before plunging by record-declines not seen since the index was started in 1990.
With such turbulence rocking the stock market, we (like most investors, we imagine) just want to know: Can we still make money in this market?
Recently, the Aston Hill Growth & Income Fund and Aston Hill Global Growth & Income Fund proved to manage the market’s highs and lows, producing a positive return this year that beat the Canadian market. And maybe even better – it didn’t lose nearly as much when the market drastically dropped in late August.
With this in mind, we turned to Vivian Lo, Vice President & Portfolio Manager with Aston Hill Asset Management, about what investors should do amidst market volatility…
- Q: Those of us with our ears pressed to the news get used to hearing the term “market volatility”, but what does it really mean?
Vivian: The technical term for volatility is standard deviation, which is simply the degree of variation from the mean. When you refer to market volatility or stock volatility, it means the degree of positive or negative returns of an index (or a specific stock) during a defined period of time. As a general rule of thumb, the higher the volatility the riskier the investment.
Each industry and sector has a varying level of volatility, which we call a risk profile. Generally speaking, commodities (like oil and gas) and materials (think metals, chemicals and forestry) are more volatile than industries like utilities and real estate, which tend to be relatively more stable.
Think of it this way: there are two paths you can take to achieve a 10% return on a stock. The first is a slow and steady grind higher, with small incremental positive returns over a longer period of time. The second is by getting larger swings, both positive and negative – you could be up 8% just to lose 4% the next day. The first path is less volatile, but could take longer and requires more patience. The second path exhibits more volatility, but you could get to your end goal faster; just make sure you have a strong stomach to weather those big ups and downs!
- Q: What sorts of things do we want to avoid doing during a particularly volatile period?
Vivian: The toughest thing for any investor to do during turbulent times is to remove emotion from your investment decisions and not panic. Don’t let the herd mentality take over your decisions, meaning, don’t follow the crowd. It’s impossible to ‘time the market’ – selling right at the top when you’ve made money, and buying at the bottom when stocks are at their cheapest. Fear and greed are the two emotions that can derail the long term success of an investor’s portfolio. Tempering these two emotions and remaining focused on your long-term investment goals can help investors get through short-term market volatility without doing damage to their portfolios.
It’s important to remember that even good companies can see their stock value decline during periods of market weakness. As an example, during the week of August 17th to 24th the Canadian and U.S. markets sold off sharply, dropping the most we’ve seen in the past four years. During that week, shares of Apple Inc. traded down eleven percent. The stock did recover over the next few days, but if an investor panicked and sold their shares that week, they would have lost a sizeable amount of their investment and not participated in any of the bounce back.
Many of us are familiar with the pattern by now: A crisis (or several) arrives, the market bounces around for some time, and then the tide calms. Do any of these stages come with their own warning signs?
There are no real sure-fire warning signs that an investor can consistently rely on to predict looming market volatility or weakness – perfectly timing the market is impossible. However, there are some indicators investors can monitor that point to a market that might be heading for some trouble; this includes:
Weakening economic indicators signaling slowing economic growth and corporate earnings
When companies that aren’t generating any cash flow are trading at exceptionally high valuation levels
Loosening lending policing, which increases the use of leverage by both consumers as well as corporations above suitable levels
- Technical factors, like when the number of companies hitting new 52 week highs starts to decline, or weakening market breadth, which is when the market keeps moving higher, but it’s being driven by fewer and fewer sectors or companies
It is important to remember none of these factors will necessarily result in market selloffs or heightened volatility, but they point to an increasing risk profile for the markets. As a portfolio manager, I always monitor them, among other indicators, closely.
At the end of the day, we investors just don’t want to lose money. Both the Aston Hill Growth & Income Fund and the Aston Hill Global Growth & Income Fund managed to beat the Canadian and U.S. stock markets as well as high yield during the recent market selloff. Do you have any tips for making money in a volatile market?
Nobody wants to lose money, but it is unrealistic to expect all of your investments will perform well at the same time. There are four tips I’d give investors:
1) Build a diversified portfolio. I’ve spoken in the past about the importance of having a diversified portfolio, not only so you optimize returns, but more importantly, to position yourself to weather pullbacks in the market when volatility strikes.
2) Have a “shopping list” ready. Even well managed, financially strong companies can see their stock get hit when market volatility strikes. Investors should have a ‘wish list’ of stocks that they’d like to buy, and at what price. That way when there’s a market selloff, instead of panicking you can quickly make smart decisions about which stocks to buy – and even better, at a discount! I recommend adding incremental amounts to the investments you have the highest conviction in.
3) Don’t be afraid to cut your losses. If your investment thesis on a company has changed for the worse – or if you realize it was wrong to begin with! – sell your underperformers even if it is at a loss. Stocks can always keep going down (and they have!). But if you still believe in your original rationale for buying a stock and nothing has changed with the company, hold onto it. During a big market selloff, everything goes down. Eventually when volatility lets up, the stock should rally higher again. (Although, this does not mean it will go back to previous levels – this is why you still need to believe in the fundamentals of the company in the first place.)
4) Add ‘insurance’ to your portfolio. We insure our houses, cars and other prize possessions, so why wouldn’t you also insure your portfolio? Adding protection into your portfolio, either through hedging or options strategies, can act as a cushion when the market sells off. Sure, you’ll give up some of the upside when the market begins to recover, but it’s worth it to ensure your investments are protected on the downside. Hedging and options strategies are for sophisticated investors though, so these tools should be left to a professional investment manager.
- Q: Are there advantages to focusing on options strategies more so than stocks during volatile periods?
Vivian: You should always have market exposure, meaning being ‘in’ the market through investments in either stocks, bonds or investment funds. Options strategies are supplemental tools that can be used to achieve several outcomes. In its simplest form, an option is the promise to either buy or sell a stock if it increases above, or drops below, a predetermined price. The two main reasons I use options within my funds are to generate income and to protect my portfolio.
- Q: What would be your one key, critical piece of advice for investors to always remember when volatility strikes?
Vivian: Don’t panic. Review your portfolio and remember why you made those investments in the first place. Before you take any action, ask yourself: have the company’s fundamentals changed, has my thesis changed, or is the story now broken? If the answer is yes, it’s time to sell, even if it is at a loss. But if the answer is no, then turn off the news, avoid the media hype, and stay the course. This too shall pass.
This commentary is published by Aston Hill Financial Inc. (“Aston Hill”). The information contained herein does not constitute a recommendation by the authors or Aston Hill to buy or sell any of the securities, commodities, currencies or other financial instruments or assets discussed herein. This commentary has been prepared using information from sources that the authors and Aston Hill believe to be reliable, however neither the authors nor Aston Hill guarantees the accuracy of such information. This report does not constitute and may not be used for the purposes of effecting an offer or solicitation of units of any Aston Hill investment products. Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus and other publicly filed documents available at www.sedar.com before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.