Diversify investments in order not to get overwhelmed by the unevenness of the economic recovery, which will trigger inevitable volatility on the markets. This is the advice of Erik Knutzen, Chief Investment Officer of Neuberger Berman, the American asset management company founded in 1939, which manages assets of approximately 340 billion dollars and which is also known for being independent and employee-owned. Knutzen suggests a “more tactical approach” to investors, to take advantage of the potential for volatility: “Recoveries rarely follow a linear trajectory. Like everyone else, we too have a basic optimism, but we try to diversify to defend ourselves against short-term risks”, argues the analyst.
At the beginning of 2021 Neuberger Berman had identified two main risk factors: the first concerned the inherent risks linked to the belief that, when the stimulus programs had felt the first effects, we would see a recovery from the beginning of the cycle. The second concerned the similarity between the current situation and the one observed in early 2010, a year that started under the banner of post-crisis optimism and ended with shares up 10%, but not without having first suffered a 12% drop. “In recent weeks – Knutzen explained -, the first of our fears has proved to be justified. The consensus view has been troubled by fears of inflation, a resurgence of worries about monetary tightening, rising bond yields and the sensitivity of stock markets to interest rates.
At the stock market level, there has been only a 3,5% decline in late January and 4% since mid-February year-to-date. These are much smaller swings than the 5% or 10% or more swings seen in 2010 and far from the level of volatility that the equity index options market is actually pricing in today. “After being “quiet” for several years, the CBOE S&P 500 Volatility Index (VIX) is now discounting an annualized volatility of more than 20% for US equities after the peak last March. The figure is consistent with the decreases in September and at the end of October. Even taking into account the premium included in option prices, it implies that market participants should expect similar declines of 5-10%”, comments the analyst.
And how to diversify, then? “When the cause of volatility on the equity markets is the increase in interest rates – argues Knutzen -, the traditional elements of portfolio diversification, i.e. government bonds can hardly offer protection. Since the beginning of the year they have lost 3-6% and, looking further down the curve, the decline exceeds 10%. In late February, the Merrill Lynch Option Volatility Estimate, which some call the “bond VIX,” soared, even surpassing the VIX itself. Among the alternative diversification assets can therefore be included those exposed to a recovery in growth and inflation, but at reasonable prices for having been neglected for a long time. For example Treasuries indexed to inflation (TIPS) or those assets that are less affected by changes in interest rates, such as commodities”.
Credit is also attractive. Brad Tank, another analyst at Neuberger Berman, explained why he stayed mostly immune to volatility which has hit stocks and government bonds: “Alternative liquid strategies that expressly aim to identify sources of return uncorrelated from the stock and bond markets can also have their say. Some of these strategies target markets that are currently attractive, such as insurance-linked strategies."
