Uncertainty and volatility must not scare you

Uncertainty and volatility can seem scary… don’t let this worry you

Uncertainty and volatility can seem scaryThe devaluation of the rand. Labour disputes in the mining and agricultural sectors. Concerns about our economic future. These issues all unsettle investors. The fact that the stock market performed well in 2012 is amplifying the fear. Investors worry the market cannot continue going up for longer. Should you be worrying about uncertainty and volatility too? What should really worry you; uncertainty, volatility or inflation?

Volatility is not risk

I always get grumpy when I read marketing material from fund managers. They brag about the low volatility of their funds as if this means their funds are somehow less risky than their competitors’. It’s hogwash to equate uncertainty and volatility to risk. Especially if you are a private person who needs to make smart, long-term investment decisions. If you want to generate real capital growth, pray for uncertainty and volatility. Investments with no uncertainty and volatility are either very low risk and stand little chance of beating inflation, or these are Ponzi schemes.

Uncertainty and volatility give opportunity

Where would you rather invest your money today, in platinum miners or the listed property sector? I’m sure many people prefer listed property. The returns have been great (especially last year). There is a good chance these companies will generate income and profit in the next few years.

What about platinum? The unions seem hell-bent on destroying their source of employment in a lethal game of chicken to get higher wages for a reducing number of employees. Some platinum miners are even being publicly targeted by Government. This is never a good sign for investors. However, if forced to allocate money to only one specific sector today, I would consider platinum miners and not listed property. There is good value in these miners. They have no international competition, so they have a natural monopoly. The uncertainty and volatility facing the sector is precisely what creates the investment opportunity.

Manage uncertainty and volatility, don’t avoid it

Most international markets, including SA, have performed well recently. Uncertainty and volatility has reduced and most equity investors are in a comfort zone. This is probably a good time to start worrying. Complacency coupled with equity investment is never healthy. The chance that equity markets will generate reduced performance in the years ahead is increasing. It will be difficult for most asset classes to beat inflation over the next three to five years.

Am I saying you should sell out of equities? Definitely not. I do recommend you diversify your portfolio across a range of sectors and asset classes. No-one knows if the stock markets will continue to run for the next year or three. I prefer earning dividends and not interest on cash. Optimally diversify your assets  in volatile conditions as an effective strategy.

The best investors never invest with absolute conviction. They realise the stock market will always do the unexpected in the short-term. This means they don’t bet the house on one particular strategy. Smart investors allocate some capital to one strategy. But if they’re wrong, they will have capital allocated to other strategies too. They do not take unsustainable losses. Absolute conviction with investment is always fatal to capital growth.

Inflation is your real risk

Over long periods of time the effect of inflation on your money is your real concern. If you don’t invest in productive assets such as shares and commercial property, you are guaranteeing the value destruction of your capital. This is especially true if you invest in cash and other “low risk” assets, because you want to avoid uncertainty and volatility. This is not a good strategy for long-term investing.

Productive assets are by their very nature volatile. Ideally you should focus on the income from these assets. If the income they generate increases faster than the inflation rate, the volatile nature of the capital invested is not relevant. It’s one of the reasons why Warren Buffett avoids IT companies. He cannot predict their income in the next 10 years. Therefore he allocates his capital elsewhere.

If the markets take a beating in the next year or two, I will probably increase my allocation to shares beyond my normal targeted percentage. But I will always maintain some asset class diversification. Just in case.

Get advice

Will you have enough money when you retire? Thinking of investing? Wondering how to repay your debt? Where to invest your money?

With a dizzying array of asset classes, asset types and more information than anyone can possibly process alone, why not speak to one of our expert financial planners? Get advice that’s tailored to your unique financial situation now.

 

2 replies
  1. Alesandro0
    Alesandro0 says:

    This article is embarrassing and clearly written by a financial market salesman. ‘Volatility is not risk’. Seriously? Volatility is a measure of the standard deviation of returns, i.e. the uncertainty of dispersion of a securities price, i.e., the level and probability of deviation (RISK) that a security will move from it’s current price within a particular range of distribution. To say that fund managers are incorrect for boasting about the low volatility of their funds is like saying you don’t agree with the fundamentals of portfolio management. The information ratio, active return, Sharpe, efficient frontier, I guess that’s all hogwash then too? Based on your rationale that volatility presents opportunity it would be more advantageous for an investor to invest in a Ba corporate 4% than an Aa at 4% (‘cos there’s apparently more opportunity’) What I think you’re trying to say is that volatility creates expectation uncertainty, and with differing expectations comes greater variability in valuations which can, if your expectations are more correct than the market, increase alpha. Read up on some portfolio management theory Warren, if not for me, at least for your poor unsuspecting clients.

    Reply
  2. Warren Ingram
    Warren Ingram says:

    Alesandro, either you are one of the fund managers I referred to in my article or you only read the headline and introductory paragraph rather than the whole article. If you take the time to read the last three paragraphs in particular, you might decide to change your comments.

    Reply

Leave a Reply

Want to join the discussion?
Feel free to contribute!

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.