Ten years of relatively low volatility has lured asset managers and investors into a complacency that has them ignoring future potential risks, according to Jason Williams, portfolio manager on the quantitative equity team at Lazard Asset Management.
A few bumps have hit the markets in the past decade, but much worse is probably coming in the next 10 years and investors are ill-prepared to weather them, Williams said in an interview with Financial Advisor magazine.
“The next 10 years will be more volatile than the last 10 years, and risk management will be central to the delivery of consistent alpha,” Williams said. “Instead of having a portfolio built with 20 or 30 stocks, a well diversified portfolio should have 150 or 200 stocks. Investors need to go to great lengths to remove risk. Investors should favor corporations with good business models, but still leave room for some disappointments.”
He added that investors should not let their attention to risk slip when constructing their portfolios as this era of central bank accommodation will end and investors who are now preparing for tomorrow’s market regime will be best positioned to sustain and grow the alpha they have established today.
“More reliable and consistent return streams may flow from portfolios that distribute their assets among many different style baskets and across many different methodologies, avoiding excessive exposure in any one position to curb macro risk,” Williams said.
While the fourth quarter of 2018 provided a fistful of volatility, the recent past has been relatively calm compared to longer-term ups and downs in the market.
“We are running below long-term averages, even with current concerns about geopolitics and the environment,” he said. “Over the next 10 years volatility will not be that low. The Federal Reserve Board's accommodations to business, which have helped fuel the stable market and outstanding returns, will not continue.”
These changes will impact asset managers. Recent trends have pushed investors to more passive management because stocks are doing so well on their own. In that sense, Williams said, investors have gravitated to passive management because it has been an easy ride. But those same circumstances, he added, have pushed managers to take more risk to try to beat the indexes and have pushed them towards more concentration.
Another factor that will impact investing over the next decade is the consideration of ESG (environmental, social and governance) issues. ESG will have much more influence in the future on how investors value companies and how companies mitigate risks.
“Investors can de-risk by giving serious consideration to ESG externalities, an area of growing investor concern that is influencing stock returns and corporate strategies to an unprecedented and growing extent,” Williams said.