Maneuvering in today’s markets

My father worked in financial services back when a conversation about insurance could easily turn into talk about the stock market. In those pre-401(k) and IRA days, the few individuals investing in the market relied on brokers to recommend stocks to them. With the move from defined-benefit to defined-contribution retirement plans, a massive influx of new investors entered the market. With the ensuing commoditization of the brokerage function, my father, like many other financial service professionals, saw the opportunity to transition to the advice and wealth management role we know today.

I often wonder how he would adapt to today’s market and industry conditions. Technology, social media, and a changing regulatory environment are rapidly altering the role of the financial advisor. And, as we all know, it’s getting harder and harder for advisors to deliver stable, positive returns to investors.

The challenges today may be the most daunting in generations. Gone are the heady bull markets of the 1980s and 1990s, when the tailwind of steady gains provided consistent rewards. Since 2000, in contrast, investors have muddled through subpar global growth punctuated by bouts of rollercoaster volatility, while an increasingly confusing regulatory environment has obscured the way forward. The consequences are damaging: Saving rates suffer, retirement security remains elusive, and traditional solutions meet with skepticism.

Investing has changed, but I believe that investors and the professionals who serve them can maneuver successfully in today’s markets, secure real value, and keep making progress toward a better financial future. It takes a combination of new ways of thinking, a strong dedication to saving, and a clear view of which investment products can serve investors best in this changed environment.

These four ways of thinking about investing today can help advisors and investors today:

Steer clear of the risk looming in the bond market. When the Fed merely hinted at a tapering of quantitative easing in 2013, the Barc Agg delivered -2.02%  for the year, its first negative result in more than a decade. Consider strategies outside of indexes and securities that are not subject to rate risk. The “spread” — or difference in yield between a sector and U.S. Treasuries of equal maturity — in these sectors presents areas of opportunity.

With rules changing, play the game in a new way. If we’ve had one constant since the financial crisis, it is expanded and poorly understood regulations. New regulation of money market funds provides a good example. It redefines what securities can be held in money market funds. So, debt securities that are now off limits have a new lease on life. By being excluded from the money market category, they offer a slight advantage relative to their more constrained money-market-eligible counterparts. Short-term investment vehicles that can exploit the space between money markets and ultra-short bond funds can simultaneously offer capital preservation as well as real higher-yield potential – certainly higher than today’s options for cash.

Balance a portfolio with a plan for the downside. Volatility may be the biggest challenge to investors. Amid a barrage of market-moving headlines, investors do not generally act rationally or with expertise. Many move with the herd. A well-diversified portfolio seeks to moderate short-term risk by taking advantage of low correlations among asset classes, thereby leading to better returns — one of the few “free lunches” still available to the average investor. It is important to both globalize allocations and include a broader set of asset classes, including uncorrelated strategies that seek absolute return. An absolute-return manager has no motivation to follow the market’s herd mentality. Instead, their foremost concern is risk-adjusted performance, a look-before-you-leap mentality. By constructing portfolios with a variety of strategies uncorrelated with each other, greater independence from market direction can be achieved.

In fluid markets, flexibility is your friend. Low economic growth, rising geopolitical instability, and elevated financial market volatility — the conditions seen over and over again in the past decade — can give anyone reason to stay away from the equity market. But big financial goals require the sort of returns that only stocks have historically provided. I believe investors can invest in stocks with confidence despite the headwinds. And in these choppy markets, active investment management is invaluable. Active managers look to earnings along with deep research into key facets of company strength like balance sheets, market share, and technological attributes. Active selection and management strategies are invaluable – I would say necessary – when such company health is not in abundance in global markets.

Making progress in tough terrain

As the 2007–2008 financial crisis fades more and more into history, the road ahead remains complicated. The debt burden remains largely unchanged, growth is fitful, and central banks continue to experiment with policies. For markets, the next five years could easily be more volatile than the previous five years.

Investors lack the luxury of waiting for better conditions, and so we must approach these challenges head on, to identify whether new sources of opportunity may be veiled by genuine risks or by exaggerated headlines. Investing is inherently an active endeavor. Market dislocations are opportunities and particularly good occasions to get back to the basics of fundamental analysis and active decision-making.

Challenging market conditions are an effective catalyst for innovation — for devising approaches that can keep up with the market’s transformations, including changing regulatory frameworks as well as evolving economic and market realities. Asset managers and advisors must find new ways to manage risk, uncover exciting investment opportunities, and strive to meet or exceed the objectives of investors who have trusted us with their savings.

No one can choose the challenges history presents, but everyone can decide how to respond.

For a more detailed discussion of how investors and financial advisors can maneuver in today’s challenging markets, download the whitepaper, “Four strategies for a world of uncertainty.”

The opinions expressed here are my own and not those of Putnam Investments, Empower Retirement, Great-West Financial, or their subsidiaries, and are not intended as tax, legal, or investment advice.