Written by Guest Writer: Chris Shuba , Founder of Helios Quantitative Research
Market volatility is normal. And though we can’t predict the future, volatility in the coming years is a safe bet. Clients look to you, their advisor, to build investment portfolios that can help them navigate through unstable times.
Clients tend to invest in what they are familiar with. They recognize U.S.-based indices like the Dow, the Russell, Nasdaq and the S&P 500, and build their portfolios with them. Currently, U.S. investors have nearly 75% of their investments in U.S.-based assets¹. Diversification, such as exposure to international markets, is a key component to a stronger portfolio and can help protect clients against volatility. As their advisor, you can provide simple recommendations based on multi-factor data to help bridge this “international” gap in your clients’ portfolios.
If you’re not familiar with the concept of multi-factor investing, it’s quite simple. Specific investment factors— value, quality, momentum, low volatility, and size—can be used to select assets that tilt a portfolio in one direction with the goal of boosting returns. For example, a portfolio that focuses on “value” seeks to identify stocks that demonstrate a favorable price-to-earnings ratio. A focus on “quality” looks at equity return, leverage ratio, and earnings variability, while a momentum-based strategy weighs heavily on stocks that have been outperforming the market for a given period and are expected to continue in the foreseeable future. Each factor-based strategy provides specific benefits depending on the market environment at the time.
The powerful thing about introducing multi-factor investing in a client discussion is that it gives you the opportunity to compare apples to apples, making it much easier for your clients to understand not only why international equities are a valuable diversification tool, but also how multiple components in a portfolio work together to help ensure sustainable returns over the long term, even in the face of unprecedented volatility. You can start by introducing the concepts of value, quality, and momentum—all factors that are easy to explain, and that most every investor can grasp quickly. Discuss how a diversified portfolio can help create a more consistent return structure, and then use real-world data and market information to create a simple model that illustrates the 12-month implied volatility for international equities compared to something every client is familiar with: domestic large caps within the S&P 500. What the numbers show is that volatility tracks quite consistently across the two asset classes.
Next, discuss how the risk associated with the two asset classes is also similar, and by overweighting international equities within a U.S.-equities-based portfolio, risk is reduced because, quite simply, the client doesn’t have all eggs in one basket. At the same time, the implied volatility chart can be used to talk through how this diversification can help smooth volatility over time.
Telling this simple story can do wonders at calming client nerves, setting their expectations not only about the value of international equities and why they serve as an important diversification tool even when they are underperforming, but also about the need to protect against continued volatility within the U.S. equities space. While the value potential for U.S. equities seems high, there’s no way to predict how long that value will last. By leveraging a cost-effective, multi-factor ETF that focuses on high quality, high value international equities, your clients can effectively “dip their toes in the water” using a tool that is specifically designed to reduce the impact of volatility on their portfolio.
¹Source: OpenfolioOpinions and statements of market trends that are based on current market conditions constitute our judgment and are subject to change without notice. These views described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations. Past performance is no guarantee of future results. Investment returns and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. ETF shares are bought and sold throughout the day on an exchange at market price (not NAV) through a brokerage account, and are not individually redeemed from the fund. Shares may only be redeemed directly from a fund by Authorized Participants, in very large creation/redemption units. For all products, brokerage commissions will reduce returns.
J.P. Morgan Asset Management is the marketing name for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide.