Since the beginning of the year, financial markets have begun a curious dance – one step forward, two steps back -, the pace being set by tweets from the White House. However, markets do not like harsh messages, which are often followed up by gentler negotiations.

As a result, mostly highly valued markets have undergone small corrections since early 2018 but more importantly, the outlook is that of performance continuing to be more volatile than in 2017.

Two things to bear in mind:

1.The development of so-called “passive” management where large investments are made in all index-based funds, whether the underlying companies are doing well or not. This general bull trend overvalues some companies and we have observed that earnings releases have had little impact when they are good (i.e. generally not far from expectations) but a much larger impact when disappointing, which in turn leads to a correction in any previous overvaluation.

2.The other type of fund management that has attracted big investment volumes is “risk management” funds that take account of potential volatility, i.e. the probability that a company will fluctuate sharply up or down.

Given that 2017 was not very volatile, at the beginning of the year fund managers with this type of strategy were able to overweight their portfolio with equities, which they perceived as lower risk, thereby curbing exposure to bonds, which are unattractive when interest rates are low, in the expectation that rates will rise. However, once volatility picks up again, as happened in February, fund managers are automatically prompted to sell some equities, which gives an added impetus to the market decline.

In this market environment where big swings are expected, it would seem wiser to opt for very reactive funds that could profit from rising interest rates (such as H2O Moderato, M & G Dynamic allocation, etc.) as well as European “long short” equity funds where picking apparently overvalued or undervalued stocks brings performance whatever way markets are trending (e.g. BDL Rempart Europe, Moneta Long Short, etc.).

N.B.: exposure to the dollar could act as a hedge against any equity market volatility. Given that Americans are the few significant global investors, a decline on Wall Street usually means that capital flows back into US stocks since they are cheaper, resulting in capital flowing out of other financial markets and a rising dollar. 

Note: while rates remain low in Europe, real estate funds continue to appeal to investors in view of buoyant returns and annual real estate appraisals lagging behind the market.

Investments are made in such funds under a ‘Perp’ or ‘Madelin’ retirement savings plan that are not currently liable to wealth tax (impôt sur la fortune immobilière – IFI).

Vincent Danis, Chairman of Savinianne.

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