Sell-offs are a normal investment experience, says James Ashley, making building in realistic assumptions for market turbulence a key task for investors and their advisers
The sharp increase in market volatility following the UK's 23 June vote to exit the European Union (EU) raises a number of questions about investment strategy.
Continued volatility as markets adjust to the economic, legal and political uncertainties of the UK's exit process can be expected. It is also plausible that UK and European economic growth could face headwinds as a result of the uncertainty and as capital flows reflect the investor reaction.
A prolonged exit and negotiation process may create a significant drag on UK exports and overall economic growth, as well as a smaller but material drag on EU growth. As European financials, insurance, UK economically sensitive equities and Sterling are, in our view, the most direct way for markets to express their views, we expect acute volatility in these areas in particular.
Key impacts
Key impacts are likely to include more dovish central banks. From a policy perspective, the Bank of England, European Central Bank and Bank of Japan could contemplate moves, but this is likely to be highly dependant on market reaction over the coming days and months.
In addition, the US Federal Reserve can now be expected to be on hold for the foreseeable future. Ahead of the UK vote, the Fed had already signalled a great deal of caution in its policy normalisation plans - and this is only likely to be amplified by the Brexit-related shock.
Sell-offs are a normal investment experience. It is well worth remembering that shocks to the system are inevitable, and equity sell-offs are historically frequent. As the following chart shows, in 15 of 17 positive calendar-year returns since 1994, the FTSE All-Share index spent some portion of the year in negative territory.
For this reason, we see building in realistic assumptions for market turbulence as a key task for investors and their advisers. After an extended period of low volatility, markets may have entered a new phrase of more historically normal - that is to say, higher - volatility.
Well-constructed portfolios can help investors stick to the plan. In our view, careful portfolio construction matters in all market environments - and especially during volatile periods such as the present. The allocation decisions that drive well-built investment portfolios should be based on more than the recent past.
As the following chart shows, an overreliance on any single asset class introduces the risk that investors may miss out on potentially attractive returns and/or increase the risk of market volatility. Taking a diversified approach can help smooth the ups and downs of any particular investment.
At Goldman Sachs Asset Management, we emphasise risk-aware portfolio construction in an effort to prepare investors for precisely these moments of surprise and market uncertainty. Although the UK's EU exit likely entails challenges for investors in the near future, our long-term playbook of strategic, diversified and risk-aware investing is unchanged.
James Ashley is head of the international market strategy team at Goldman Sachs Asset Management
