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Alternatively, a shock can come from seemingly nowhere, such as a more pronounced challenge to the Eurozone from Italy or a large devaluation in the Chinese currency.


Portfolio challenges in a transition environment Staying the course with risk asset markets appears a gamble given the likelihood of the ultimate large reversal. However, anticipating the downturn by selling risky assets is also a problem since the transition phase can still see the market gain significantly over its duration. Neither is diversification into assets with intermediate risk-return characteristics that easy a compromise. The diversification promise may not materialise one way or other as made clear by the experience of the financial crisis and the very low return profiles in some cases thereafter (as with most hedge fund strategies).


What should be done?


It appears to us that the better course is portfolio adjustments that incrementally move towards lower risk-taking. Ultimately, making some moves, even if early, will be better than taking no action at all. Here are some actions to consider, most of which are standard risk mitigation measures:


– Looking at more defensive approaches within asset classes as well as across the broader mix of assets.


– Using diversifiers where not currently much used or raising exposures in this area – intermediate risk- return assets are the opportunity set here.


– Using any weakness in bonds to build or increase positions. Clearly the higher yields are, the more it pays to build positions, but it is time in these conditions to not be too greedy on yield levels.


– Considering portfolio overlay-type protection strategies. With the timing of market downturns uncer- tain, open-ended protection strategies would seem best, if available and affordable.


Ultimately, it must be appreciated that in dealing with a transition environment, some risk will have to be taken. Either it will be a case of being too early and foregoing gains directly or costs incurred from pur- chasing insurance; or in the case of not doing anything or not doing enough, of being too late to protect capital adequately.


It is weighing up these opposing risks for portfolio moves that make the transition environment so chal- lenging. It should hopefully also be clear that this challenge cannot be avoided. Market cycles are like that.


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April 2019 portfolio institutional roundtable: Managing volatility 23


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