Volatile markets spark a revival of active investing

It’s been a turbulent 18 months, to put it mildly.

Market volatility, as measured by the VIX Index, has seen huge spikes since the start of 2022, and for good reason. There has been Russia’s invasion of Ukraine in February 2022 and the UK’s swiftly reversed mini-budget in September, not to mention soaring inflation, subsequent rapid interest rate hikes, heightened geopolitical tensions and frequent rounds of sanctions, led by the US and China.

All these unknowns create considerable risks to economic growth, day-to-day commercial operations and the value of financial assets.

So it is hardly surprising that markets are on edge. Despite a period of relative calm in June, when the VIX – often known as the ‘fear gauge’ – fell to its lowest levels for over three years, investors are expecting volatility to rise again.

Nearly three-quarters of those surveyed for a wide-ranging study by EquitiesFirst in collaboration with Institutional Investor’s Custom Research Lab said volatility would increase in their market of focus. The report gauges the outlook for global equity markets of some 300 investment decision-makers at a wide range of asset managers, foundations, pension funds and endowments.

Volatility creates opportunity

Of course, savvy investors can benefit from volatile markets – by being greedy when others are fearful, to paraphrase Warren Buffett. Survey respondents most commonly expected volatility increases to come in Asia-Pacific and European emerging markets, which suggests there will be opportunities for those brave enough to take them.

Emerging markets are typically less transparent and less liquid – and therefore more often mispriced – than their developed peers, a situation further exacerbated by volatility. Under such circumstances, active investment strategies can prove especially effective. Indeed, active managers have long argued that they perform best during volatile times.[1]

Sure enough, active managers experienced increased inflows in the first quarter of 2023 on the back of growing interest in emerging market and credit strategies, according to Investment Metrics.[2]

The EquitiesFirst x Institutional Investor study reflected this thinking, with respondents taking the view that concentrated high-conviction strategies will be more effective in emerging Europe and Asia Pacific markets than in developed ones.

Growth preferred to value

The study also shows a strong preference among investment-decision makers for growth over value investing. The former typically buys high-quality stocks that have the potential to deliver above-average growth, while the latter targets aims to purchase under-performing companies before their operating results and market performance turn more positive.

Strong support for growth over value strategies

The current preference for growth strategies may well be tied to a belief that we are heading into a period of sustained economic growth, with the emergence of new high-growth companies or offerings from well-established innovators that are well positioned to prosper under such conditions.

By contrast, value strategies are more likely to thrive during periods of moderate economic growth and low capital costs, when high growth opportunities are often elusive and index strategies suffer from tepid growth and profitability.

As the study highlights, investors worry that since value stocks are often over-leveraged, they are particularly vulnerable to the present environment of high interest costs, low profitability and uneven cash flows. As such, many investors say they plan to rotate out of value equities into higher-growth, well-established high-tech and information-intensive companies.

There are several other strategies worth adopting in times of heightened volatility, including a focus on diversification, regular rebalancing of portfolios and staying abreast of market news. Informed and nimble investors have a better chance of outperforming the market.

Given the long list of current unknowns – including when inflation will ease, the direction of US Federal Reserve policy and how issues such as the Ukraine war and US-China trade relations will pan out – institutions need to be able to dynamically adjust their asset allocations.

Securities-backed financing can provide that flexibility. Investors can use their equities or crypto assets as collateral to fund quick moves into new positions and diversify their portfolios without having to sacrifice the upside potential of their holdings.

[1] https://www.institutionalinvestor.com/article/b1yz0rz06xjl4k/Active-Managers-Are-Proving-Their-Worth-Right-Now-Will-It-Last

[2] https://www.institutionalinvestor.com/article/b1yz0rz06xjl4k/Active-Managers-Are-Proving-Their-Worth-Right-Now-Will-It-Last


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