The speed at which risk moves through markets is creating new challenges for investors, who need to adjust their portfolios to deal with the phenomenon, according to Principal Global Investors.
Choosing large cap stocks over small, having a strategic allocation to long-dated Treasuries and some exposure to real estate are some of the methods the $452 billion asset manager suggests to hedge against what it has dubbed “risk velocity.”
“It’s not necessarily the case that markets are markedly more volatile than they’ve been in previous cycles,” wrote Seema Shah, Principal’s chief strategist, in a report. “It’s the pace at which risks can transition between the potential and the kinetic, to use an energy analogy, that’s never been more rapid.”
Drivers of this increasing “risk velocity” include a disconnect between the price of assets and the expectations of the underlying economy, a heightened downgrade risk and potential forced selling from investor positioning in lower-rated bonds, and the interdependence of global supply chains, Shah wrote. The shift of political news from planned addresses to posts on social media has also been a factor, she said.
“When combined, the overarching effect is that the market’s positive or negative response time becomes shorter,” Shah said.
While Principal doesn’t believe growth has slowed enough to presage a recession or that risk assets are no longer attractive, it does suggest investors take steps to hedge against increased risk velocity.
Todd Jablonski, chief investment officer for Principal Portfolio Strategies and a contributor to Shah’s report, emphasized U.S. large-cap equities as an opportunity to hedge.
Mega-caps in particular can take advantage of their size, go all over the world to the most favorable locations and translate decisions into business opportunities, he said in an interview. They “offer downside protection but they participate in the upside,” he said. MDT/Bloomberg