Mitigating Investment Portfolio Volatility

By Gary Brent on February 26, 2016

Mitigating Investment Portfolio Volatility The simple fact is that global markets are volatile. While this is always true, it is particularly pertinent presently, in the aftermath of the 2008-2009 global financial crisis when investors saw serious declines in their portfolios and the collapse of some alternative investment strategies.

Regardless of global market volatility, affluent investors seek investment advisors who can build portfolios to successfully mitigate volatility – even in turbulent times.

Balance Risk with Goals, Not Relative Returns

Whether your portfolio has been successful or not should not be measured by relative benchmarks, but rather by whether the portfolio is meeting your goals at an acceptable level of risk.

As we discuss in our recent video, Relative vs. Absolute Benchmarking – Debunking the Investment Industry in Canada”, portfolios structured to be compared to a relative benchmark can be built with an over-emphasis on growth – which can result in depleted capital, missing funding requirements, and an unnecessary amount of risk.

Instead, an investor’s tolerance for risk and volatility should be assessed and then balanced with market conditions and the pursuit of their specific investment goals in the short, medium, and long term. This approach allows investors to structure their portfolios based on their actual needs and goals, and helps them remain committed to their investment plan in both good and bad capital market conditions.

Assessing Investors’ Tolerance for Risk

Portfolio volatility is a reality of investing in nearly all securities, but individual investors’ tolerances for volatility and risk are very personalized.

Different investment advisors may approach assessing risk attitudes differently – and some may not do it at all. At HighView we have worked hard, in collaboration with behavioural psychologists, to establish an effective assessment for investors’ attitudes toward risk.

We determine a client’s Attitudinal Risk Profile based on four key dimensions: capacity, knowledge, experience, and willingness. A client’s unique mixture of these elements allows us to score their overall attitude toward risk.

From this score, we then structure a portfolio that we anticipate will behave in a manner consistent with what the client will be comfortable with. This portfolio is then compared to the portfolio that will best match their investment goals, in order to ascertain if there are any gaps between the two that need to be addressed.

Designing Portfolios to Match Investors’ Tolerance for Risk and Meet Investment Goals

We firmly believe that how an investor’s portfolio behaves over time, and through various market cycles, is at least as important as the longer term returns it generates. The foundation for this belief stems from our direct experience with investors and their demonstrated lack of comfort with significant drawdowns in their portfolios.

While a particular portfolio structure may prove beneficial over time, if the investor is not able to accept the shorter term volatility, then they are likely to force liquidation at an inopportune time.

To effectively address this, investment advisors must recognize how the various components are expected to function together when structuring a portfolio. By doing so, they can create a portfolio that will perform in a way that not only meets the investor’s needs and goals, but also is comfortable for them over time.

To accomplish this, a rigorous focus on risk, as opposed to returns, is the key.

We construct client portfolios according to four levels, in a ‘top-down’ process:

  1. Asset Class: What asset classes will be included in the portfolio (equity, fixed income, real estate, cash, etc.)?
  2. Investment Mandates: What investment mandates will comprise the portfolio (Canadian equity, US mid-cap, Canadian Laddered Bond, Canadian Corporate Bond, etc.)?
  3. Investment Managers: What investment managers will be employed to satisfy the investment mandates?
  4. Investment Vehicles: Will the Investment Managers appear in client portfolios through the use of Investment Funds or individual securities (stocks and/or bonds)?

We then perform an in-depth analysis to see how this type of portfolio is anticipated to perform during extreme market events. We fully discuss this with the client prior to investing. As a result, when we enter periods of increased market volatility, there are no surprises for our clients.

HighView Financial Group is Canada’s outsourced Chief Investment Officer. We specialize in helping affluent families build goals-based portfolios. Set up a complimentary discovery session to get to know us and see if we’re the right team for you!

You may also be interested in:

Link to blog “Debunking the Investment Industry: Is Your Investment Portfolio Structured for Relative or Absolute Benchmarking? [Video]”

See Beyond

Receive Market Commentary + Stewardship Insights.