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Managing an investment portfolio is always difficult, but current market conditions are testing an investor’s commitment to long term goals to the fullest. With tough conditions in the market, managing volatility has become the primary goal of any prudent investor. So how can one go about it?
In addition to using portfolio strategies such as diversification and regular rebalancing, there are special investment vehicles to create optimal risk-adjusted portfolios. These vehicles use hedging through derivatives, structured products and exposure to alternate asset classes such as commodities, hedge funds and private equity to reduce volatility.
Structured products
Structured products help to hedge volatility from traditional investments due to their ability to reduce downside risks. Wealth managers offer principal-protected structured products for investors looking to participate in equity returns along with capital protection. Structured products can also be flexibly designed to play an investor’s view of the market. For instance, Edelweisss has recently designed products which provide positive returns when index returns are negative. Our constant advice to investors has been to replace long-only portfolio allocations with principal protected structured products.
Managing currency risk has become critical in the Indian context as the rupee is showing high volatility. Investors should look at investing offshore in the global markets for two reasons. One, overseas investments offer access to a number of investment strategies such as hedge funds and long-short investments which are not available locally. Offshore investments (exporting currency) act as a natural hedge to currency risk.
Dynamic asset allocation
Another powerful tool to reduce volatility is to have a dynamic asset allocation approach, using cash and cash equivalents. Since early this year, for instance, we have been of the view that markets are going to be volatile and have advised clients keep 15-20 per cent of their investment portfolios in liquid funds.
Not only does the cash component reduce the volatility in the portfolio, it provides liquidity when opportunities present themselves in the current volatile market phase.
There are many ways for investors to manage their portfolio volatility. Investment decisions should be taken from a portfolio perspective and should be aligned to each investor’s risk-return objectives.
(The author is Head – Edelweiss Global Wealth Management. The views are personal)
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