Yesterday, I appeared as a guest on CNBC’s “Closing Bell.” One of the topics we discussed was market volatility and the role of lower-volatility equity strategies, which seek to avoid downside without foregoing the opportunity to participate in stocks’ upside. The interview was similar to many of the recent conversations that I’ve had with investors. Here are some of the key points I’ve been making in these conversations.
In my view:
- Volatility will likely continue at an elevated level. Falling commodity prices, global growth fears and political uncertainties in the euro zone are among the factors that will add to volatility in the markets over these next months.
- The U.S. stock market can continue to advance for 2015. The U.S. economy looks set to continue its expansion, supported by accommodative Fed policy, healthy job growth, and good corporate profit growth. Valuations are attractive by a number of our favored measures, and especially for growth companies.
- Investors need to look through the short-term volatility and position their portfolios proactively and strategically. Downside protection is important. Investors need to settle into an allocation that won’t tempt them to market time or sell into weakness.
- Diversification is important—but bonds aren’t necessarily the right answer, or the only answer. We believe there are risks in the bond market. Short-term rates may stay low through much of 2015, as the Fed takes a “patient” approach. Even so, it’s important to remember when rates move, they can move quickly and take investors by surprise. Also, many factors can influence long-term rates, beyond what the Fed does.
- Lower-volatility equity approaches are especially well suited to this environment. What can investors do if they are concerned about market downside but don’t want to abandon their long-term goals? I believe strategies that include both stocks and convertibles can be especially advantageous for investors who are struggling with the “afraid to be in the market, afraid to be out of the market” dynamic.
Convertible securities combine stock and bond attributes, providing the opportunity for upside participation and downside protection. More specifically, convertibles can benefit from upwardly rising stock markets because they are equity sensitive, while their fixed income attributes may provide a floor of sorts when the stock market is volatile. Compared to traditional fixed income securities, they are less sensitive to interest rates, so investors may not have to scramble when rates do begin to rise. However, because all convertibles do not have the same upside and downside attributes, they must be actively managed to provide the right risk/reward balance between upside participation and potential downside protection.