As challenges including the Russia-Ukraine war, high
inflation and supply chain constraints continue, compounded now by rising
interest rates, there are several steps advisors can take to help their clients
overcome their top concerns, according to Dan Kemp, global chief investment
officer at Morningstar Investment Management.
Although the worst of the pandemic may be behind us and
society is returning to something close to normal, investors remain concerned
about lingering challenges like inflation possibly getting even worse, he told
the Envestnet Advisor Summit in Charlotte, North Carolina on Wednesday, during
a session called “Navigating Investor Concerns in 2022.”
Clients are “full of worries” and topping their list of
concerns in 2022 are global conflict, inflation and rising interest rates, he
said.
Stay on the Rollercoaster
Those are all important concerns that advisors must take
into account but none of them is the most important issue, he noted, adding:
“The most important thing is whether clients are on track to meet their goals,”
especially with short-term losses in their portfolios that are part of an
“emotional rollercoaster” for them. “It’s easy to forget how stressful
investing is,” he added.
“Our shared goal is to keep them on the path to where they
want to be” and it is crucial to address clients’ concerns and try to get them
to avoid making investment mistakes.
Kemp guessed that most clients are likely not looking to
take more risk now. But he said: “Prices are lower. It’s a far better time to
take more risk now than it was a year ago.”
Many investors “want to get off the rollercoaster and not
invest anymore [and] we know that’s disastrous because once people get off
they’re very, very bad at getting back on,” he explained. “Their goals can
become completely unattainable if they jump off at the wrong point,” he added.
Addressing Clients’ Common Concerns
Addressing each of the three top investor concerns, he said
first: “The impact of geopolitical events is entirely unpredictable … I have no
idea what’s going to happen next in Ukraine.” He guessed that very few people
aside from Russian President Vladimir Putin do, he added.
The future overall, meanwhile, is uncertain and could bring
any of a huge range of outcomes, he said.
The best way to combat geopolitical uncertainty is to create
a robust, diversified portfolio for each client that can deal with all four
market environments (low inflation, high growth; high inflation, high growth;
low inflation, low growth; and high inflation, low growth), he explained.
To combat inflation, advisors should use a flexible,
unconstrained investment approach, he said, pointing out all Morningstar
portfolios are managed with a valuation-driven approach that helps mitigate the
impact of inflation.
To combat rising interest rates, he said, investments should
factor in high interest rates. Historically, value has outperformed growth
during environments of higher interest rates, he noted.
So what’s best now are positions in value-oriented sectors
including energy and financial services, and high-quality businesses with
economic “moats” that tend to insulate them from inflation via greater pricing
power based upon consumer loyalty and the ability to negotiate favorable terms
with suppliers, he said.
Meanwhile, alternatives may be a better choice than fixed
income now. After all, alts are less affected by rate hikes because they have
less of a correlation to the market, he pointed out.
3 Predictable Patterns of Behavior
There are three predictable patterns of behavior during
times of market volatility, he also said.
First is a fight in which investors try to take control and
“trade through” the turbulence and there is an increasing reliance on
short-term predictions of market sentiment, he noted.
More dangerous is flight, in which investors sell their
riskier holdings to reduce volatility in their portfolios. Although they may
benefit in the short term, goals are endangered as investors fail to re-invest,
according to Kemp.
The last type is freezing and doing nothing, while trying
not to look at their portfolios, while some enter “analysis paralysis,” he
said, noting that can lead to a failure to make changes when they are required,
reducing future returns.
Guiding Investors’ Responses
There are also four keys that should guide responses to
economic and market trends by advisors and investors, he said.
First is staying true to the process. In other words,
investors should be long-term and valuation-driven, focused on ensuring
appropriate diversification to deal with varying economic and market
conditions.
They should also recognize uncertainty. There is no
advantage over other investors in predicting the future and times of
uncertainty require a significant margin of safety, according to Morningstar.
Review fundamental values by conducting continuous research
on markets potentially affected and doing an annual review of model
assumptions.
Implications for positioning also must be considered.
Uncertainty around fair values implies portfolio robustness will be especially
important. That is why Morningstar continues to review and evolve portfolios to
ensure advisors have responded in a measured way to shifts in relative
attractiveness, he noted.
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