How to tackle investment risks in 2024

Current market conditions highlight some significant challenges for investors. The important thing at this point is to accept the reality of market risk without getting upset. It’s easy to get lost in the constant stream of market news and speculation, often referred to as a “black swan hunt.”

As an investor, it is important to separate this noise from the facts by focusing on long-term investment strategies rather than decisions driven by panic caused by temporary market fluctuations. If anything, lean into the volatility and reframe the nervousness as excitement for opportunity.

As we approach the start of 2024, it is critical that investors harness the power of behavioral science to navigate the risks inherent in the economic and geopolitical landscape. As a starting point, let’s all agree that uncertainty will always exist and that sometimes scary headlines dominate our collective consciousness.

Nevertheless, stocks, which make up the bulk of most investors’ portfolios, have managed to return 7.4% per year over the past 100 years, even after inflation (S&P 500 total real return, annualized),2 Despite two world wars, investors have been able to compound returns. , the Cold War, a global pandemic, and various regional economic crises. It’s a change in perspective from the narrow perspective of “What happened?” The broader question “How do market cycles evolve?” is key to helping imperfect decision makers make wise choices in the face of irredeemable uncertainty.

Markets hate uncertainty and negative surprises

Given the number of known risks facing the start of 2024, the resilience of the broader market may come as cold comfort, especially for markets with short investment horizons. The samples below are a top priority for us.

While this set of concerns is daunting, it’s worth remembering that not all risks will require an entirely new portfolio to survive if they materialize. A well-calibrated portfolio that combines global stocks, bonds across a range of maturities, and a carefully selected hedging strategy designed to limit overall interest rate risk, at least for us, will protect us from external shocks. It should be able to withstand it as well.

In other words, you can build a robust portfolio that can withstand a variety of contingencies. You don’t need to have a crystal ball to know what will happen next. Rather, you can build a portfolio that finds and protects value within a wide range of “what ifs.”

In fact, to the extent that an external shock suddenly causes negative sentiment, we are likely to view price movements as opportunities. This was the case, for example, during the coronavirus pandemic. Recall that in March 2020, global stocks plummeted and bond markets, including the U.S. Treasury bond market, known as a global safe-haven asset, froze due to liquidity concerns. As the pandemic progressed and the lockdown continued, we had no better foresight than anyone else about the range of potential outcomes. What we knew was that asset prices had fallen far beyond our normalized fair value estimates.

As a result, portfolio managers around the world Added Analyze the risks of stocks (e.g. energy stocks), high-yield bonds, emerging market bonds, etc. as soon as possible. The rest is history. After a 22% correction between February 20, 2020 and April 7, 2020, global stock markets have rebounded significantly. Despite huge losses, the Morningstar Global Markets Index returned 16% for all of 2020.

What are the techniques to reduce portfolio risk?

Not all external shocks follow the path of COVID-19. Some actually impair cash flow, meaning the fair value of the asset deteriorates permanently. A recent extreme example? Russian stocks after the invasion of Ukraine.

Also, portfolios may not be as well-adjusted as investors think. Perhaps it’s because the position was not sized correctly considering all the risks, or the fundamentals underlying the offsetting position were not fully understood. The latter is true for investors who assumed that long-term government bonds always fully offset the risk of stocks. Strong returns from stocks helped recoup much of the losses in 2022, but given the traditionally low returns of the bond market, fixed income investors will make up for the 6.25% annualized losses over the next two and a half years. may take even more time. .

Of course, that doesn’t matter if you can reliably predict both the risk and the subsequent market impact. But we argue that it is essentially impossible. Consider the most significant events in recent market history. It’s the coronavirus and the lockdown. global inflation. Aggressive central bank policy. Few of these developments were accurately predicted, and even if a particular investor could point out one risk, he could not predict the rest.

With an awareness of uncertainty firmly in mind, we believe that the best approach to managing geopolitical or other external shocks is through ongoing fundamental asset class analysis and careful portfolio construction.

With these two tools firmly in hand, let’s take a look at the 2024 risks we’ve identified. Include the expected impact of these risks, the opportunities that may emerge, and any potential offsets that could potentially reduce the possible harm.

New risk response approaches towards 2024

Key points regarding external risks in 2024 include: External risks are always present, but the majority are related to volatility, and we believe there are as many opportunities as there are potential losses. The essence of external shocks is uncertainty in both timing and magnitude.

Without a doubt, many risks are potentially higher than those mentioned on this list, we just don’t know about them yet. With this uncertainty in mind, we believe that having a robustly constructed portfolio that takes all possible outcomes into account is a key element to successful investing.

Valuation risk is often ignored, but it really matters

Overestimation risk is a real problem that is never on the list of what could happen. Everything has a price, and fluctuations in perceived risk can lead to mispricing. Is there any bad news? The valuation is likely to increase. Are you aware of the many risks? The possibility of an attractive price.

Some blue-chip companies have high valuations and need significant growth to meet market expectations. In this regard, we believe that the very narrow market leadership of large-cap US technology companies in 2023 provided an interesting investment environment looking to 2024 and beyond. Much of the U.S. market’s rally in the first half of 2023 was driven by exceptional earnings from a handful of companies. That’s not to say that the so-called “Magnificent Seven” aren’t great companies, but their valuations are high and they need significant growth to meet market expectations.

Simply put, some markets have no room for error or disappointment. Other markets are pricing in stories of despair — in the case of stocks, Chinese stocks — that only need to do a little better. Fundamentals matter, especially when interest rates are high, so investing where there is a valuation buffer or margin of safety will be key for the coming years. This is a story that is repeated over and over again in the market.

Is there an upturn in China?

To be clear, we recognize the uncertainty surrounding these markets and do not have as clear a picture as other companies of how they will develop. To address these concerns, we rely on scenario testing to determine our positioning. What we ask is:

1. Assuming the worst happens, how much can you hold without jeopardizing the overall performance of your portfolio?

2. Are there overlapping exposures here that are not obvious at first glance? How can these risks be managed?

Valuation is an underrated tool for turning risk into reward in your favor. And where headline risks are plentiful, tomorrow’s great opportunities are often found.

New risks, consistent approach

Patience and perspective are key in the world of investing. Before taking action, consider what is already priced in and how the market is adjusting. Risk may sound scary at first, but it’s not necessarily a bad thing. Risks can be a catalyst for opportunities if managed carefully. After all, in the world of investing, risk not only creates the possibility of loss, but also paves the way for profits.

Risk and reward are two sides of the same coin, and investors cannot expect big returns without taking some risk. This doesn’t feel intuitive because our brains aren’t wired to be patient or willing to accept uncertainty. Historical headlines don’t help. But discipline and a long-term perspective never go out of style, and investment principles can pay off most in turbulent times.

The risks we face heading into 2024 are significant, but not insurmountable. The key is to remain calm, focus on the long term, filter out the noise, and apply robust risk management techniques. Remember that even in the face of risk, there is opportunity. With a thorough understanding of the market, a sound strategy, and a cool head, investors can not only navigate current market conditions, but also spot potential opportunities within them.