5. May I speak with you in private? Another approach to limiting volatility is taking some capital out of public markets and investing in or lending to private companies. Private equity funds generally require a 10-year plus commitment as they buy, improve and sell assets. Private credit can have a shorter duration and can introduce an income component. Both types of funds give managers the latitude to create long-term value for investors away from the noise of daily valuations, quarterly analyst reports and retail investors' overreactions to exogenous events. Private markets also allow managers to use their relationships to gain an information advantage in sourcing and acquiring attractive assets. Private equity is a broad asset class that includes companies from early (venture) to late (buyout) stages, as well as private real estate and infrastructure. The latter could be particularly interesting if the Trump administration is able to realize its ambitious public/private infrastructure plans.
6. Have a plan for deploying cash. High-net-worth investors are currently holding large allocations to cash, which can serve the dual purposes of lowering volatility and saving “dry powder” for the next great opportunity. Rather than risk missing entry points as markets move, investors should consider hiring managers with the flexibility to move exposures and the expertise to do so effectively. For those who want to manage the cash more actively themselves, consider placing small toehold positions with managers—that way, you can move quickly to increase positions, rather than trying to start investment relationships during a pullback. A caveat is in order here: A manager making a purposeful allocation to cash in order to mitigate risk and prepare for opportunities is quite distinct from his being required to hold cash to meet regulatory requirements or to fund potential redemptions. The former situation describes some hedge funds, while the latter describes all mutual funds.
7. Patience is a virtue. Even when active management really delivers, it can take time. An overvalued (or undervalued) company may stay that way for a protracted period. Against the backdrop of highly volatile markets, investors seeking to profit from mispricings should be all the more willing to wait for the situation to correct. Funds that do not permit daily withdrawals—provided the liquidity provisions are matched to the underlying assets—can protect investors from other participants' weaker impulses as well as their own. In a downturn, mutual fund clients have tended to redeem their investments, often forcing managers to sell at exactly the worst time. Funds with a longer redemption window, on the other hand, can be buyers of the resulting underpriced assets.
Conclusion: The market has rewarded passive investors for several years now, and the low cost and high efficiency of passive strategies suggests that they merit a long-term position in portfolios. At the same time, there are signs that change is afoot: a new administration and the execution of a new political agenda, a transition away from coordinated monetary easing and a dramatic migration of assets from active to passive investing. Skilled active managers, particularly those running alternative strategies, have the potential to protect investor capital and even profit from the volatility that tends to accompany such significant change. But investors need not choose wholesale between active and passive or try to time a turn in the market environment. Active and passive strategies can be complementary, and a combination of the two may offer needed balance in the face of uncertainty.
James Waldinger is CEO of Artivest, a tech-driven investment platform expanding access to private equity and hedge funds for financial advisors and their HNW clients.