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The benefits of being on vacation

Staying invested over the long run is often the best route to wealth growth and preservation.

August 22, 2024

23 mins

by:

Manpreet Gill Chief Investment Officer of Africa, Middle East and Europe

Wealth Insights: The benefits of being on vacation

Summer vacations can be wonderful things. Besides the obvious benefits of taking time away from the day-to-day work, as investors, they can sometimes help us refocus on the long term rather than over-respond to what may be flash-in-the-pan events.

This summer proved to be a great example of this. Global equities fell over 8% from mid-July to early-August amid concerns about US economic growth, doubts about the immediate benefits of AI investments made by leading companies and a surprisingly hawkish Bank of Japan. By mid-August, though, equities almost fully recovered their pullback. Investors who were returning from vacations in mid-August noted that equities were largely at the same level as at the start of the month and wondered what all the fuss was about. Those of us who were in the office, though, spent a rough couple of weeks, given the speed and magnitude of the pullback. With the benefit of hindsight, the best course of action was to do nothing.

The pressure to act

As human beings, we are wired to act when faced with a potentially adverse situation. This fight-or-flight response means that when significant events (like a sharp market pullback) occur, we often feel the need to ‘do something’. In many situations, this is well warranted. If one’s physical well-being is at risk, one would be much better off doing something when faced with a threat.

When it comes to investment portfolios, though, this is not always the best response. We know from decades of financial market history that getting and staying invested over the long run is often the best route to wealth growth and preservation. This means fighting against the temptation to retreat to the (perceived) safety of cash whenever markets are volatile.

Favour equities, but review the assumptions

Getting and staying invested does not mean inaction is the best approach. There is nothing wrong in reviewing one’s assumptions as new information becomes available. Today, we are positive on equity markets based on the view that the US economy will be able to avoid a recession.

It is reasonable to review the validity of this assumption when data release is much weaker than expected. However, we would distinguish this from over-reaction to one data point or market volatility. In the recent case, we believe the volatility was significantly exacerbated by investor positioning that had become excessively optimistic, a risk we had been flagging in our early summer notes. On balance, we still believe staying invested in a diversified portfolio with a modest preference for equities remains reasonable today.

Should I hedge?

History shows risky assets such as equities deliver the highest returns over the long run. In practice, we know the volatility of the asset class can make a very equity-focused investment too volatile for many investors. This is where investors can use several tools.

One is simple diversification. With inflation having come off the boil, the negative correlation between stocks and bonds appears to be returning. This means, through diversification, bonds could once again offer an attractive route to reducing the volatility of an equity-heavy portfolio. Unless our assumptions are significantly challenged, we would continue to view positioning-led pullbacks of the kind we just experienced as opportunities to add to such diversified portfolios.

A second tool is to add hedges. There is unfortunately no asset class that serves as a ‘perfect’ hedge. History shows us that while mainstream hedges such as government bonds, gold or the Japanese Yen can do well in a wide range of risky scenarios, they have all failed as a hedge against market volatility from time to time. Hedges, by their nature, can usually hedge only against specific risks.

However, a basket of several risk hedges can help increase their effectiveness. Today, for example, energy equities’ sector can offer a hedge against unexpected geopolitical risks, making it a useful addition to a basket of more traditional hedges such as high-quality bonds or gold.

Balancing action with inaction

In our H2 2024 outlook, we noted that while we continue to see a case for moderately preferring equities over other asset classes within a diversified allocation, markets were likely to be more volatile than what we experienced in H1 2024. The most recent experience of summer volatility illustrates the challenges such volatility can create. Besides just going on vacation and not over-reacting to events, we believe investors can use a variety of tools (such as diversification or hedges) to help themselves stay invested for the long term. This would also create room to reassess long-term fundamentals without being excessively swayed by day-to-day market volatility.

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