With financial markets expected to experience increased volatility as tensions in the Middle East rise, investment executives warn that risk diversification in portfolios has never been more important.
Earlier this week, following Israel’s invasion of Lebanon, Iran launched ballistic missiles at several military and security targets in Israel, sparking an alarming new exchange of threats between the two states.
With Israel pledging a “painful” response and Tehran warning it would unleash “vast destruction” in response to any retaliation, markets are set for a tough time.
As uncertainties and tensions continue to weigh on financial markets, safe-haven assets like gold and the US dollar continued to appreciate on Thursday.
“Exogenous event risk, whether geopolitical or otherwise, serves as a reminder that risk diversification can be useful in mitigating the volatility of portfolio performance to a level consistent with an investor’s risk tolerance, while mitigating the risk of intolerable losses due to extreme events. events,” Karunakaran said.
“Portfolio risk diversification is really about diversifying equity risk, that is, reducing total portfolio volatility and downside risk in scenarios where equity markets suffer large losses.”
While alternatives are often seen as a way to diversify equity risk, Karunakaran cautioned that many alternative investments incorporate significant equity beta, which tends to manifest during times of market stress.
He also warned that high-quality government bonds, often touted as the defensive asset class of choice, “are no longer as reliable as they used to be” in a regime of higher inflationary uncertainty and lower levels of inflation. higher public debt.
“Reliable risk diversification comes from adding investments whose underlying return drivers are genuinely different from the factors that drive stock returns, especially in extreme scenarios,” Karunakaran said.
“When volatility increases, whether due to escalating tensions in the Middle East, systemic crises or other market events, investments of a more defensive nature, such as gold bullion, stocks Gold stocks, government bonds, the US dollar and US Treasuries, tend to dampen the portfolio while other riskier assets fall,” he said.
“This is why, in a strategic asset allocation context, many investors include alternatives like gold and US Treasuries, which have a place in portfolios due to their low correlation with classes traditional assets like stocks. »
Ultimately, maintaining a long-term outlook is crucial given that volatility tends to dissipate over time, Neiron said.
“Successful long-term investors survive short-term downfalls by sticking to investing principles that have stood the test of time. For portfolios, this may include better diversification,” he said.
Calling diversification “crucial,” Ashley Glover, head of sales at CMC Markets, highlighted the importance of spreading risk across asset classes.
But he also believes that volatility can prove fruitful to some extent, pushing investors to potentially adjust their asset allocation or portfolio size based on their risk tolerance.
Additionally, volatile markets can present buying opportunities, Glover said.
“Stocks or other high-quality assets may become undervalued, providing long-term growth potential,” he added.
Although gold and cash are well-known diversifiers, he highlighted higher risk assets which, when properly considered, can behave defensively in portfolios.
“For example, in times of heightened geopolitical uncertainty, we often see defense sector stocks outperform. This is currently happening in stocks such as Lockheed Martin, which is up more than 50 percent over the past year,” Glover said.
