Investors will be rewarded for their patience if they maintain portfolio discipline with a view beyond the short-term, according to market analysis by JP Morgan Asset Management.
Although global stock markets have become more volatile amid an uncertain outlook for global growth, central bank policies and political risks, JP Morgan’s analysis recommends investors maintain their composure.
“Investors who can see beyond short-term volatility will make better investment decisions,” says Anthony Collard, head of UK financial investments at JP Morgan Private Bank. “We believe there are three simple principles that can help: keep market volatility in perspective, focus on the long term and maintain portfolio discipline.”
Having the fortitude to stay invested during difficult periods requires discipline that has often been rewarded. For example, in 2014 the maximum drawdown of 7.4 per cent occurred during October over various global concerns. And in 2015, the largest pullback occurred in August when anxiety over growth in China escalated.
“Despite the negative market reactions and subsequent volatility, neither episode was a reaction to underlying economic growth trends,” Collard says. “Consequently, those who stayed invested throughout each period benefited from the subsequent market rebounds.”
Broad market returns behave differently over daily, monthly and annual periods. Although market timing is alluring to investors who are attempting to avoid losses, this approach can be frustrating and result in poor performance.
“The ups and downs of daily returns are smoothed over during the course of months and years,” says Collard. “Overreacting to short-term volatility is likely to backfire. Since 1928, 65 per cent of years have enjoyed positive returns, with average gains far outpacing losses.
“Expanding the investment holding period over years and decades has in the past improved the risk/return profile of an investor’s portfolio. Simply expanding to a five-year period brings a dramatic improvement.”
A 10-year window only performed poorly during the Great Depression and the Great Recession. Stock returns over 10-year holding periods from 1936 to 2003 were positive. Notably, there has never been a 20-year period in the post-war era that has suffered losses.
Following a disciplined and diversified investment approach may help to manage stock market volatility. “By rebalancing investments in line with a long-term view on the outlook for the economy and markets, a multi-asset portfolio may achieve higher returns with lower volatility than any individual asset class,” Collard adds.
Solid returns and smoother performance for a multi-asset portfolio result in a superior risk/return profile. The realised Sharpe Ratio, which measures the trade-off between returns and volatility, is higher for a multi-asset strategy than individual equity markets. This holds true over 10-, 15- and 20-year horizons.
Investors should continue to expect stock markets to be volatile as the current business cycle matures, JP Morgan says. In this type of environment, it is even more important to distinguish between volatility caused by short-term news rather than long-term fundamentals, and to stay focused on the latter.