Year ahead 2021: seeking clarity amid macro uncertainty
As market volatility could persist in 2021, how can investors cut through the fog of uncertainty?
The US stock market has been awry since 9 March week1 as oil prices plunged after Saudi Arabia threatened to increase production in April. In a policy response to mitigate the economic impact of this new disease, the US Federal Reserve2, Reserve Bank of Australia3 and the Bank of England4 have cut rates.
We know it’s hard - as markets shift rapidly and this disease spreading across continents - to hold down the sense of anxiety you may be feeling over current volatility and ultra-low yields.
Don’t let volatility derail you
As markets fluctuate, you may wonder whether to divest from one asset class and move into another that could fare better in such uncertain times. Be aware of the volatility that you can handle, keeping in mind that troubled times aren’t a sign to sell everything.
Investing generally involved significant drawdowns from time to time. Markets move in cycles and through peaks and troughs. So even as popular signals start to indicate difficult times ahead, it can still pay to remain invested.
Do consider diversification
A key to navigating market volatility is diversification. Instead of focusing on a single asset class, investing in assets that have low or negative correlation could help smooth portfolio fluctuations under different market conditions.
As the chart shows, no single asset class can stand out as an all-time outperformer over the years. Equities, for example, took up the top three performing asset classes in 20195 but market have been relative eventful so far this year.
As winners rotate, it is crucial to have a diversified portfolio so that you won’t miss out on the opportunities to capture the upside potential of different asset classes.
Learn more: Principles for successful long-term investing
Do keep quality at the forefront
As you consider diversification, keeping a focus on quality could better help you select securities in an asset class.
For example, fixed income generally has relatively lower risk compared with equities and it is an essential component for portfolio allocation, based on investors’ objectives and risk appetite.
Fixed income covers a wide spectrum from traditional sectors such as government bonds and investment grade bonds to non-traditional sectors such as mortgage-backed securities (MBS) and asset-backed securities (ABS).
Fixed income sectors such as agency MBS6 could act as a diversifier to portfolios as it tends to be less correlated to risk assets such as equities and high-yield (HY) bonds7. Unlike equities and HY bonds7 which are more closely tied to corporate balance sheets, the underlying assets of agency MBS are mostly mortgage loans. This means tapping into the balance sheets of home buyers.
In addition, agency MBS are perceived as an alternative to US Treasuries. Issued or guaranteed by US government entity or government-sponsored enterprises, agency MBS still carry little credit risk which is translated into the slight yield premium it can offer versus US Treasuries. The 12-month rolling average yield of US MBS was about 2.6% as of the end of February 2020, compared with 1.7% of US Treasuries8.
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For investors, generating a reliable source of income throughout their investing lifetime is vital, especially in an ever-changing market environment. Seeking a diversified portfolio with a long-term horizon could help investors ride through volatile markets. And it is important to focus on quality, without overstretching for yield, when selecting securities in an asset class.