Why investors might be ignoring the biggest market risk

Why investors might be ignoring the biggest market risk

Why investors might be ignoring the biggest market risk News around stretched valuations in the North American markets has been hard to escape in recent months. Investors have been waiting for a market jolt as geopolitical tensions have continued to rise in almost every corner of the globe. So far, the markets have shrugged their shoulders as the world enters a new age of turbulence.

Chad Larson, ‎Senior Vice President, Portfolio Manager at National Bank Financial, sees another current market theme as being more concerning than the valuations story: the popularity of low volatility strategies. “The amount of money flooding into these low vol strategies makes them even more low vol, so, if there is a market event that causes investor sentiment to get bearish or a market correction, my fear is that we are going to see more pain on the low vol names,” Larson says. “They have become the darlings with their quantitative factors and rule-based investing, but that probably carries the biggest amount of risk in the market.”

Volatility is often bandied around as a negative term, but in times like these embracing it is crucial to achieving to good returns. As well as carrying an elevated weight in cash this year, Larson has looked into the Eurozone and emerging markets for investment opportunities. “From a valuation perspective, maybe there is better value to be found in the Eurozone and emerging markets, but you’re also taking on more volatility,” Larson says. “The Eurozone hasn’t really recovered from the 13s and 14s and shows a lot of opportuntity. It is a great place to get a developed market with better comparable returns to that of Canada.”

Many Canadian advisors complain that their clients are reluctant to embrace strategies that invest in Europe and emerging markets; investments perceived to be risky. Larson believes that, for advisors, it comes down to making a decision on whether to be a true advisor or simply a service provider. The easy option is to give clients what they want and Larson compares this to feeding ducks: clients quack and then get fed something they want to eat. The harder part of the business, Larson says, is building meaningful realtionships and working to understand who your clients are and what they need, not just what they want.

“It takes a few conversations of reminding people that, in the grand scheme of things, Canada is an emerging market – it’s output is peanuts in the grand scheme of things,” Larson says. “Look at the Euro Stoxx 50, for example. It has some household names that people can relate to. The association or attrition fallacy is common among clients – if they know something, they feel safe. Telus may be a great company, but we have a saturated market for cell phone users. I would rather be in something internatonal that is continuing to add customers.”

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