The fall in global stock markets in 2022 has resulted in many people searching for low volatility investments. We haven’t seen markets behave this erratically since the financial crisis of 2008/9. To make matters worse, fixed Interest investments and property funds have also suffered; it appears there is nowhere to go to protect ourselves from the downside.
Cash is the only asset class where capital can be protected, but high inflation eats away at any interest we might be able to squeeze out of the banks.
The good news is that low volatility investments can offer protection against falling markets. More about that later. First a word of warning. There are a number of esoteric investment ‘opportunities’ which promise great returns with apparently no risk or fees. Social media is riddled with such offers, and effective adverts tempt potential investors. This always happens when stock markets fall. The usual spiel implies that stock market investing is dead and the only way to protect yourself from volatility is to invest in the latest fad fund. Cracks start to appear when we look ‘under the bonnet’ and draw on past experience of similar market conditions.
We have seen one after another of these so-called alternative or non-correlated investments promise the earth and deliver nothing but financial pain to those who invest. Everything looks great at first, then suddenly, one day, the fund and its promoters disappear into the ether. Think of the stereotypical masked criminal wearing a black and white striped shirt, running away with a bag marked ‘swag’!
Tell-tale signs that can be identified in advance warn us that some investments might not deliver what they promise. The checklist below isn’t inexhaustive but will protect most investors from fraud.
- Is the fund regulated in a recognised and internationally respected location? Most ‘wrong ‘uns’ are unregulated and based in obscure offshore tax havens. This means investors have virtually no redress should the fund fail.
- If you make an enquiry, do the promoters insist on arranging a meeting before any information is provided? Regulated investment advisers must publish Key Investor Information Documents (KIID) on their websites and pre-sale.
- Are charges opaque or transparent? If the promoter is unwilling to send full details, they are trying to hide them. This means fees will be considerably higher than expected. Regulated advisers will always be happy to send full fee details and declare the commissions they receive.
- How liquid is the investment? For example, wine and whisky funds can only be redeemed by selling bottles or barrels. The clear implication here is that investors who want to withdraw money can only be paid by new entrants to the fund. A certain Mr Ponzi operated this way, and we all know what happened there. Ironically, an investment which is based on liquid is simultaneously illiquid!
- Are you being asked to ‘buy now while stocks last’? Again, never a good sign and is a common tactic used by those whose motivation is to relieve you of your money. There is always another opportunity.
- Never forget there are ‘lies, damn lies and statistics’. Most scams quote eye-wateringly high potential rates of return at nearly no risk. This should set the red lights flashing straight away. Steer well clear of anything that uses the word ‘guaranteed’. Nothing in life is guaranteed; this applies to the investment industry as much as anywhere else.
- Another well-known cliche is that ‘if something looks too good to be true, it probably is’. Run the cliché test every time you consider an investment.
- Only work with regulated advisers. Do your background checks, and don’t rely on (probably fake) review sites.
Low volatility investments can offer protection against market falls
Low-volatility investments can smooth out the markets' ups and downs. Although investors don’t benefit as much when markets constantly rise, the reverse is also true. As a result, downside risk is limited due to protection mechanisms inherent in the product.
We are all happy to expose ourselves to investment risk when markets defy gravity. However, current market conditions have highlighted our real risk appetite. The rise and fall of Crypto-currencies clearly illustrate this concept. Social media was awash with posts from the new ‘Investment Gurus’ when cryptos doubled and more in value. Where are they now? I would suggest licking their wounds and re-evaluating their real risk appetite.
Risk profiling is not just a question of where to invest in good times; it’s also how you would react in more challenging circumstances. If we are truly honest with ourselves when considering this question, we would often find our tolerance to extreme volatility and losses isn’t quite as high as we think.
If this is the case, low volatility investments that limit downside risk should always be considered. It may not be as exciting as riding the roller-coaster of cryptos or direct stock investments, but sleeping at night might be easier.
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