How to make your portfolio more resistant to volatility

Investors have long been attracted to private market investments for the enhanced return potential on offer.  But they could provide you with greater portfolio stability too.  

Volatility has returned with a vengeance. “Artificially low interest rates and other favorable monetary policies contributed to big market gains [over the past decade] with little or no interruption,” Natixis observed in its 2023 Global Individual Investors Survey.  From 2012 to 2021, the S&P averaged annual total returns of 16.5%, including gains of 31.5% in 2019, 18.4% in 2020, and 28.7% in 2021. “But high inflation, rising rates and growing uncertainty have combined for increased volatility.”  

The VIX average hit 25.94% in 2022, while the S&P 500 was down almost 20%, its worst year since 2008.  Bonds delivered their worst losses ever.  And the majority of institutional investors polled for the 2023 Natixis Outlook Survey predict volatility will be even higher in 2023.¹ 

Fragile public markets 

Asset Risk Consultants noted that equity markets were choppy in August and generally ended the month down.  Bond markets also lost ground.  As a result, all four of ARC’s private client indices – which are based on the performance of about 350,000 portfolios from 120 investment managers – were in the red for the month.²  

With inflation proving stubborn, no clear view on the trajectory of interest rates in major markets, and concerns over the prospects for recession or even stagflation, we can expect more of the same in the coming months. 

Highly-skewed equity markets are adding to the volatility prospect.  The “Magnificent 7” large technology-related companies (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms) are up 95% to 31 August this year and together account for over 70% of the S&P’s rise in 2023.³  Moves up or down in such keystone stocks can have outsized portfolio impacts, leaving investors hostage to the performance of a tiny proportion of the public market universe. 

The rise of passive investing post-financial crisis will exacerbate the market swings, warned the Natixis survey: 69% of respondents believe large flows in and out of passive products exacerbate market volatility, while another 60% believe the passive segment’s popularity has increased systemic risk. 

Private markets sanctuary 

Given the outlook for “elevated levels of volatility, more rate hikes and recession,” two-thirds of the institutions surveyed by Natixis believe a portfolio comprised of 60% equities, 20% fixed income and 20% alternatives will outperform traditional 60/40 portfolios.  

The attractive return potential and reliable payment schedule that private equity and private debt offer are a major draw.  The floating-rate nature of some private debt instruments also provides an inflation hedge, Preqin CEO Christoph Knaack noted in a recent interview. 

While investors increasingly turned to private markets over the past decade to make up for low-yielding bonds, said the Natixis report, they are now looking to “private assets to provide relief on the equity side of the portfolios as well.”  About half (48%) believe private markets will provide a safe haven in a recession, up from 35% who thought that in Natixis’ 2021 outlook, as confidence in the recession-proofing role private assets can play has grown. 

Improve portfolio stability 

Private markets are not immune to the weaker outlook.  But they tend to have a low correlation to public markets, noted Barclays Private Bank,⁴ so adding a private markets allocation to a traditional equity-bond portfolio could potentially improve portfolio returns. 

“Whereas listed markets are often subject to sharp short-term swings, often overshooting, private markets are somewhat sheltered from such volatility, as there is no daily pricing,” it said. 

Private valuations nearly always adjust more slowly and more modestly, in part because “private markets focus on investment cases that typically involve above-market growth and margin expansion over multiple years, making them less focused on the current public equity valuation environment when valuing businesses,” explained Jeffrey Diehl, Adams Street’s Head of Investments⁵.  

Fewer, less immediate updates can also help investors resist the urge to panic-sell and stay focused on long-term investment goals, Barclays added. 

Plus there is greater choice.  The number of private companies globally has grown sharply as more stay private for longer amid the shrinking appeal of going public, with private companies now outnumbering listed ones by almost seven to one. 

This wealth of choice though makes forensic due diligence of the available investment opportunities all the more important, capabilities individual investors lack.  The answer: partner with managers with the specialised expertise to evaluate deals and navigate this complex – yet rewarding – environment. 

This content is for information purposes only. Treble Peak does not provide investment or tax advice, and information on this website should not be construed as such. Potential investors should seek specialist independent tax and financial advice before investing in any alternative investment.  Past performance is not a reliable guide to future returns. Your capital is at risk.

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