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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we spoke with Anthony MacGuinness in Dublin, the head of the quantitative strategies group at Irish Life Investment Managers. We discussed the value of risk-management strategies in unpredictable times, and we started by getting his take on current market conditions.

Anthony MacGuinness (AM): Despite the very strong growth we’ve seen, like markets up maybe 30% since the end of October, we do believe the outlook for global equities and risk assets is still well supported. We believe the stimulus that we’re seeing from monetary and fiscal authorities will prove supportive for risk assets. And we do believe that the effective rollout of vaccines – although logistics are difficult in certain regions – I think the market will look through some of those risks, and probably look to – although likely a weak Q1 – a probably strong second half of the year in terms of economic activity. So, we will be constructive on growth assets, and probably see interest rates and bonds treading water over the next 12-month period.

What does he make of current equity valuations?

AM: We do see valuations in the U.S higher than the longer-term averages. If we’re looking at their price versus the next-12-month earnings, they could be trading at 20 times in a year. However, if you compare that valuation versus 2022 earnings, we’re looking at a valuation multiple of around 17-and-a-half times. So that’s expensive versus history, but we think when we factor in the extremely low level of bond yields that we’re seeing in the market, that those type of valuations are sustainable.

What about in the long run?

AM: When we look over the long run, we do need to be mindful of the fact that valuations do feed through into projected forward earnings and it points to the need for a diversified portfolio, being mindful of the risks taken within that portfolio, and how you are going to manage that, because at these levels of valuations and, obviously coming out of Covid, there is definitely the opportunity to see greater levels of volatility going forward.

How he looks at risk management.

AM: There are many ways of approaching risk management. Diversification within equities – across styles and regions – is certainly one way. Secondly, then, some approaches may be more trading orientated, so tactical asset allocation, approaches whereby people would look at the level of valuation in the market sentiment, macro factors, [etc.,] and consider whether the overall level of return is appropriate, and they look to adjust their weight in equities. That is another way of approaching this. A third approach, which we have incorporated is the concept of utilizing derivative strategies or option strategies, where we can give a more risk-reduced exposure to equities. Clients may be looking to take some risk to generate necessary income and return in a portfolio but conscious of the losses potentially that come with that. So, derivatives can play a role in terms of reducing that overall level of risk that the investor is taking, through buying protection. Protection is expensive but we fund that protection by selling away some upside in the market.

What about the risk of inflation?

AM: If we do see inflation increase, I think that could cause a quite destabilizing impact for investors in their portfolios. There’s two ways, typically, that we would approach dealing with that problem. One would be to work harder in terms of that searching for alternatives to fixed income to provide diversification in a portfolio. But another way, then, is to seek to overlay that with some kind of risk-management technique which would try and control the level of risk within the asset allocation, and not just rely exclusively on fixed income as a diversifier.

And, finally, what is the lesson here?

AM: We have seen significant change in the investment environment and backdrop. We need to think differently about building portfolios. We need to think about risk management techniques, allowing investors to take the risk they need while also being able to do that in a competent fashion, such that if and when we see volatility, that doesn’t destabilize the savings plans those investors have set up.

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Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Anthony MacGuinness, the head of the quantitative strategies group at Irish Life Investment Managers.

Join us every Wednesday at InvestmentExecutive.com, where you can sign up for our AM newsletter and never miss another Soundbite.

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