Welcome to the March 2022 Manager Panel! Each month, where relevant, InvestNow will ask some of our fund managers some questions surrounding a topic. This month we asked Milford, Smartshares, Harbour Asset Management and Fisher Funds, some questions in regards to current market volatility and future market predictions. Read their responses to the questions below.

Q1: How should investors react, if anything, to the heightened volatility in current markets?

Since 2018, investors have been experiencing increasing bouts of volatility in financial markets. These episodes should have given investors a feel for how their investments perform and whether those investments are suitable for their risk appetite. Whilst volatility (particularly sharp falls) is not particularly pleasant to endure, by now investors should realise that it is a feature and not a bug of financial markets. Having stress tested their risk appetite over the past few years, investors should avoid making changes now to long term financial savings vehicles on the basis of short-term swings in markets and the headlines that accompany them. Concerns can often be allayed by speaking to a financial adviser or checking how your fund manager is managing their funds through this environment.

Q2: How is Milford responding to the current market volatility?

As an active investor managing funds that have a high degree of flexibility, this environment offers us plenty of opportunities to add value in our funds. This might be through boosting returns by identifying opportunities provided by cheaper stock prices, avoiding some of the falls in markets or a bit of both. Towards the end of last year, we recognised that the investment backdrop had changed with central banks forced to confront surging inflation. Interest rates will be raised sharply and materially around the world for the first time since the mid 2000’s. With shares and government bond valuations both elevated, we have reduced our exposure to both as well as repositioning our funds to reduce exposure to very highly valued growth companies. On the other side we’ve accumulated cash and added commodity stocks that can benefit from the boom in raw material prices.

Q3: What are your future predictions for markets?

We don’t think the broad outlook is that rosy for many financial markets. The global consumer is facing headwinds of high inflation, rising costs of borrowing and little prospect of meaningful fiscal support from governments. Broadly speaking, share valuations still look high and profit growth is uncertain at best. But it’s not all bad news, there are plenty of companies where valuations are not only reasonable but are downright cheap. Furthermore, even as growth slows there are many companies that will be thriving. So we are not short of ideas or opportunities to invest. The outlook is one of more volatility with ongoing swings in share prices, both up and down. The geopolitical developments are likely to continue to deliver headline risk to markets but even if we see a much hoped for resolution to the war, this does not materially change the outlook.

Q1: How should investors react, if anything, to the heightened volatility in current markets?

Given all the alarms bells we are hearing about how the tides have turned for the markets — it might seem counter-intuitive — the best thing to do is to not give in to the urge to react in the short term if you have a long-term investment timeframe. History is the best witness. The S&P 500 has since the late 1930s not been in the red for more than 3 years in a row. What this means is after falling, the market always recovers. Investors’ instinctive reaction is to run for cover. Selling means having to absorb the losses. Staying invested means having the opportunity to recoup losses when the market rebounds.

We tell our investors to keep their investment timeframe in mind. For those with a longer timeframe, this means staying invested in the market over a long period, setting the right risk versus reward expectations, and regularly checking to see whether these expectations are still valid. Someone getting closer to retirement age might, for instance, need to reduce their exposure to higher-risk assets, and increase their cash, or fixed-interest assets. With our SuperLife Age Steps option, for example, an investor’s more volatile growth assets will be reduced, lowering the expected size of the ups and downs in the value of the investment.

Q2: How is Smartshares responding to the current market volatility?

Volatility has been a constant for as long as there were too many willing sellers but no willing buyers, or there were many willing buyers but no sellers. Remember the boom and bust of the tulip mania, the oil shock of the 1970s, the rise and demise of the dot.coms, the shock of the Gulf War, and not-so-long ago the global financial crisis? These were all highly volatile episodes in history.

At Smartshares, we prepare ourselves daily for changes in the markets. Part of what we do is looking ahead at the impact of changes in interest rates and economic trends, and taking pre-emptive actions to cushion the impact, if any. Last August, we did a few things to reduce member’s exposure to the threats of rising interest rates. We reduced our exposure to Australasian and international equities, and increased investments in infrastructure and listed property funds. We also increased our exposure to foreign currencies, such as the US dollar, which often appreciates during periods of risk aversion.

Q3: What are your future predictions for markets?

The current macro-economic environment is not particularly good for either stocks or bonds.

Central banks will need to raise interest rates to slow the pace of consumer price inflation that we are seeing at the moment. That has a direct negative impact on the return on bonds as investors adjust their outlook for interest rates and inflation. In stock markets, valuations appear more expensive as the cost of capital rises and corporate margins are squeezed by rising input costs and slowing economic growth.

The good news is that markets have already adjusted prices to reflect the uncertain outlook. Stock market valuations are much more attractive than they were, particularly in growth sectors, such as technology. Also, bonds now offer the highest yields they have in almost five years.

However, it will take some time for markets to gain comfort that central banks can successfully rein in inflation without having a significant negative impact on economic growth.

Investor sentiment is also already quite fearful of the potential outcome of the Russia/Ukraine conflict, and not without reason. This event could have a significant negative impact on economic growth globally, particularly in the European region. The greatest impact globally will come from high oil prices as this can fuel already sharply rising consumer prices, and dent consumption at a time when consumer confidence is already low.

This part of the investment cycle favours defensive stocks that can pass through rising input costs or have long lease terms and long-term fixed borrowing rates such as listed property and infrastructure. Value can outperform growth stocks in a rising interest rate environment provided the economy only cools modestly during this period.

Government bonds also tend to do better than corporate bonds in an uncertain environment and can offset losses in stocks should the situation worsen.

Q1: How should investors react, if anything, to the heightened volatility in current markets?

Maybe try not to look at your investment balance too often.  If the investment was designed to meet your objectives when you originally invested, then it’s probably still the right one for you. Investing is a generally long-term endeavour.  Current volatility is a sobering example of why this is so.  Given time, markets should recover along with those quality companies that benefit from the environment we then find ourselves in.

When markets normalise, investors could use the recent market volatility to learn more about their tolerance for risk, and think about the suitability of their current investments. How much does uncertainty affect you on an emotional level?

It’s important to acknowledge our own behavioural biases. For example, research shows the pain of losing is about twice as powerful as the pleasure from winning. This “loss aversion” may cause us to be overly conservative and avoid taking risks, even if our investment time horizon means we could afford to invest in riskier asset classes.

Q2: How is Harbour Asset Management responding to the current market volatility?

Professional investors like Harbour use time-honoured investment disciplines to overcome those behavioural biases that all humans have. Applying our ongoing research and analysing data, we identify opportunities that may arise due to mispricing to continue to actively manage investment portfolios.

During volatility like we are currently seeing, Harbour is taking advantage of lower prices to buy more of the stocks we like while they are “on sale”. As an active manager, we know the companies that we invest in very well, and if we liked them at higher prices, then we like them even more now. Good companies with solid businesses can sometimes get caught up in indiscriminate selling as investors seek to reduce risk. We want to take advantage of this for our clients.

It is important to acknowledge the uncertainty that has created the volatility. We don’t know how the Russian invasion of Ukraine will play out, or how far interest rates will rise, so we are paying close attention to reliable data and research, and actively managing risks in our portfolios.

Q3: What are your future predictions for markets?

The turning point in markets will only be known in hindsight when we have the data to prove it.  Nobody can reliably predict when this will happen, not even the professionals. While uncertainty is high, we believe future outcomes for some asset markets are skewed. NZ short-term interest rates, for example, embody aggressive expectations for the Reserve Bank of New Zealand to quickly increase the Official Cash Rate to almost 3.5%, up from 1% currently. However, with the economy already slowing we don’t think all this tightening will be delivered, providing scope for interest rates to fall. This has clear positive implications for fixed income assets (as bond prices rise when yields fall) and also positive implications for some NZ equity prices, as investors may not need to discount future earnings by as much as current interest rates suggest.

Q1: How should investors react, if anything, to the heightened volatility in current markets?

We know that investing can be a very emotional process for people, and that is amplified when markets are volatile.  Being aware of and managing our human tendency to avoid loss is one of the key factors to a successful investment strategy.  We encourage investors to reflect on their reason for investing and whether anything has changed.  Was your reason, for example, the potential to grow your investment over time at a rate higher than cash at the bank? If your reason for investing still holds true, then it should hold true that you continue to focus on your long-term plan and look past the short-term volatility.

There is a famous phrase, “it’s always darkest before the dawn” which equally applies to investing. Markets have shown us time and time again that the greatest gains come following periods of major corrections, and even more importantly markets do recover.

Q2: How is Fisher Funds responding to the current market volatility?

Market volatility not only cause indices to fall, but it can also result in a material dispersion in the performance of different stocks. As bottom-up fundamental investors we try to use market dislocations like the current one to buy stakes in high quality businesses that have temporarily gone “on sale”. We are currently finding more attractive equity and credit ideas than we have since the Covid sell-off in 2020, so the team has been busy identifying these opportunities and selectively making new investments with a focus on delivering long-term performance. 

Q3: What are your future predictions for markets?

It is too difficult to predict near developments, however we take comfort from the fact that the current list of investor concerns is long. With the recent market correction, rising interest rates, surging inflation hitting consumers in the pocket, and the war in Ukraine, there is already a lot of pessimism baked into markets. Valuations have retraced significantly and outside of the US they are in line with long term averages. The recent corporate earnings season has also demonstrated strong underlying corporate profit growth, despite the inflationary cost pressures. While we can’t expect the same high returns markets have delivered over the last decade, we are certainly not as pessimistic as many of the news headlines. We remain positive on the outlook for markets in the years ahead.