How to protect portfolios when surprise events strike

How to protect portfolios when surprise events strike

How to protect portfolios when surprise events strike Two of the biggest events of this year – Brexit and the Trump victory – have highlighted just how difficult it is to forecast outcomes. And that difficulty doesn’t just relate to the votes themselves, but also to how the markets react. The common consensus was that, if the British were to vote for Brexit, sterling currency and assets would sell-off significantly and there would be big loses.  Although sterling did fall initially, the impact on the currency was not nearly as dire as many predicted.
 
“The broader implication for globally diversified UK investors was that their portfolios increased in value, because the declining sterling meant their overseas assets increased,” explains Todd Schlanger, Senior Investment Strategist with Vanguard's Global Investment Strategy Group.  “When we look at the portfolios we built for UK investors and our diversified single fund solution, they all increased in value as a result of Brexit.”
 
“However, model portfolios here in Canada and the US suffered losses of, on average 3%. But then, the market recovered within a few days and those portfolios are all up in value since Brexit.”
 
It’s a similar story with the US election. Trump won, the markets were supposed to sell-off but, after an early overseas decline, the markets have since been up. In order to profit from these types of events, investors need to first correctly predict the result of the vote and then guess right on how the market is going to react, two factors which 2016 has proven to be almost impossible.  “The result is that investors are rewarded for two things through both of these events: being diversified and being disciplined,” Schlanger says. “If you are both of these as an investor, you would have done pretty well through these two big events.”
 
“Know your goal, build a diversified portfolio and be disciplined in your approach. Given the muted return outlook, it’s important to implement your portfolio at a low cost. If you do all those things, you’re going to be successful.”
 
Vanguard’s view is that we’re in a state structural deceleration, which will result in low growth for the foreseeable future. “In the short-term, we may see higher growth and inflation. But our longer-term view is that we’re going to be in a lower growth environment because of the structural issues around aging demographics and workforces and lower labour productivity,” Schlanger says. “Volatility tends to spike in election years, and it will be here for a while as we get more information around what Trump can actually put into practice. However, in the long run, the markets go back to fundamentals and based on where valuations are for equities and fixed income, we wouldn’t predict outsized returns for the market.”

Schlanger believes that a reasonable expectation for returns in the global equity market is in the 5 - 7% range, and 2 – 3% for fixed income. “When you put that together along with a muted inflation outlook, you’re looking at real returns in the 3% range over the next ten years for a 60/40 balance portfolio,” Schlanger says. “That means cost is going to be very important in the upcoming years.”


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