IAIN ARMITAGE, GLOBAL HEAD OF CAPITAL MARKETS
With market volatility likely to persist, families are using strategies that seek to generate income from such conditions as well as the potential to buy equities at lower levels.
KEY MESSAGES
While heightened market volatility is psychologically testing, we also believe it represents a time of opportunity
Warren Buffett famously said that a wise investor should be “fearful when others are greedy, and greedy when others are fearful.” We see a lot of families doing just that.
Heightened volatility is one of the most reliable indicators of fear in equity markets. Spikes in equity volatility typically trigger investors’ instincts to “fight or flee.” The VIX Index – which measures implied market volatility by way of S&P 500 options pricing – hit an all-time high of 82.69 in March, driven by the extreme uncertainty over the COVID-19 pandemic. While such turbulence is psychologically testing, we also believe it represents a time of opportunity.
Getting paid to wait
Citi Private Bank has long recommended strategies for qualified investors that seek income from equity market volatility and simultaneously offer potential exposure to equities at lower levels. While we do not advocate market timing by waiting for lower equity prices, we do believe investors can “get paid to wait” through structures that give investors a return based on prevailing volatility or a lower entry point in the event markets do fall. And with volatility still elevated, such strategies have the potential to pay investors at the moment.
For many, the daily consumption of COVID-related news stories fires our amygdala, heightens our fight or flight response and obscures the longer-term play. Many investors would like to invest in equities at today’s attractive levels.
On the other hand, they believe another leg down in the markets might create an even better entry point. Torn between "FOMO" – fear of missing out – on potential upside in the near term and the fear of missing out on a better buying opportunity later on – they end up doing nothing – see The wisdom of lump-sum investing: Why you should get fully invested.
For some, this has been the impetus to act to capture yields and better position their portfolios.
Consider what we have actually seen in the first four months of this year. For illustration purposes, say an investment in the S&P was made every day between 2 January and 30 April 2020 - figure 1. That’s 197 separate purchases. Eighty-three of those (42%) would never have seen the market fall by 20%. By contrast, the other 114 investments (58%) would have experienced a market that fell by 20% or more. But now, as we look back, not a single one of the 197 investments was underwater by more than 20% by the end of April.
This means that if you can accept that your investment might experience volatility and are also on holding for the longer term, there is an opportunity to extract value from the market. We therefore recommend considering strategies that can turn volatility into income or provide you a better entry point. Both are good outcomes.
As of mid-May, equity volatility has pulled back from March’s record highs. That said, the VIX Index1 is still 60% above its 2019 average level. Volatilitybased strategies are thus attractively priced for suitable investors. For the rest of 2020, our view is that volatility will remain elevated and subject to sharp moves in reaction to pandemic developments.
For suitable investors of this type, an approach that pays some return today, plus the potential to buy equities over the next year at lower levels may provide diversification and profit potential.
1 The VIX Index is a real-time market index representing investors’ expectation of 30-day forward-looking volatility. Based on S&P 500 Index options, it is often known as the “fear gauge.”
Source: Bloomberg, as of 18 May 2020. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is no guarantee of future results. Real results may vary.