Fund Selector: Coping with mood swings

A ship’s captain knows the sea is a worthy but ruthless opponent.

This is something investors should keep in the back of their minds when constructing their portfolios. Recent market volatility and upcoming events – the most immediate one being the US debt ceiling – mean investors need to take a respectful but wary view of the market.

There is a saying: “Markets will do whatever they can to prove most investors mostly wrong for most of the time.”

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Since the early summer, you cannot open a newspaper or tune into a broadcast about investment without coming across forecasts of doom with regard to emerging markets.

Yet what has happened since is quite a different story. Emerging market equities have outperformed those in the developed countries by approximately 10 per cent. Take Russia for example. During the past three months, Russian equities have risen by approximately 12 per cent, while the S&P 500 has risen by only 4 per cent. In the past month, Russian equities have risen by 6 per cent and the S&P 500 is down by about 0.5 per cent.

On a six-month timeframe, however, Russia is down 6 per cent and the S&P 500 up by just under 4 per cent. So those who sold Russia at the start of this period should be showing a gain.

What we can take from this is that markets routinely exhibit extremes of optimism and pessimism. To cope with – and profit from – the mood swings, investors need to combine tactics with strategy in terms of asset allocation.

Strategy reflects a long-term view, of between five and seven years ahead. Tactics are for the short term, ranging between six and 12 months into the future.

A position may be proved right over the long-term, but many investors will not wish to wait. This is where the blending of tactics and strategy comes in. Investors need to choose their entry and exit points shrewdly. This does not mean discarding their long-term view, but it does mean they need to adapt to short-term circumstances.

Peter Fitzgerald is head of multi-asset at Aviva Investors