Strategies to manage risk in a difficult market

Jacques de Villiers
December 18, 2018

Despite short-term pain for existing investors, periods of significant stock market drawdown do not have to be about suffering and loss. It can often represent an attractive entry point for long-term investors. Hypothetically speaking, investors with the foresight to avoid the worst down periods whilst participating in all the upside would enjoy incredible returns. However, in reality, this is much easier said than done.

‘Time in the market beats timing the market’

Large stock market moves tend to be concentrated in just a few trading days. Therefore, attempts to time the market are often doomed to fail due to this phenomenon. As a consequence, it is best to follow a disciplined approach to investing and realise that a strategy cannot be built around timing the market, but should rather focus on what allocation is required to achieve your long-term objectives.

Keeping to your strategy

When tempted by current market fluctuations, investors should stay true to a long-term strategy or plan. There is a lot of psychology in the market but desire and impulse is never a good rationale for an investment decision. If we look at the dot-com phenomenon, we saw what a clear hot bubble burst was. Does this mean that you should put all of your money in just stocks or just bonds? Just because an investment type or style outperforms one year, there is no guarantee that it will outperform in the future.

Are you inadvertently contributing to a possible tech bubble?

When looking back at the early 2000s, many a speculative investor sustained a loss without proper research on the sustainability of a given company’s profit and cash flows. This is essentially gambling. Whilst we still could see new companies springing up more frequently due to advances in technology, an unsustainable growth pace is still a genuine risk that markets face today. The dot-com events from the 2000s demonstrate how vital it is not to follow market sentiment blindly. It is vital to rely on thorough company research and to ensure the company you are investing in fits with your risk profile and investment philosophy as well as the current holdings in your portfolio.

Market research shows that FAANG (Facebook, Apple, Amazon, Netflix and Google parent, Alphabet) shares have outperformed and this is clear in their constituent weighting of approximately 11% of the S&P500, nearly double, what it was in 2013. This skewed weighting attributable to the tech sector can lead to an imbalance within investment portfolios and contribute to overly optimistic investor sentiment and unrealistic expectations of the market as a whole.

Investors should keep perspective and remain realistic, as history has repeatedly shown us that bear markets and corrections are an inevitable part of being an investor.

Overview of recent changes to GICS sector classifications (GICS = Global Industry Classification Standard)

From September, the Telecommunication Services sector was renamed as Communication Services and will include companies that facilitate communication and offer related content and information through various media sources. The newly renamed sector will include existing telecommunications firms (such as Verizon), some previously classified as IT (Facebook/Amazon) and some previously categorised in Consumer Discretionary (Netflix/Walt Disney). Amazon will remain in the Consumer Discretionary sector, while Alibaba Group and eBay will now join Amazon from the IT sector.

Given that more than 10% of the S&P 500 index has been re-classified, it could create some short-term volatility in the impacted companies/sectors as index trackers and the like take steps to rebalance.

Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security.

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