Symmetry Policy: How to Adapt to a More Volatile Market Environment
It’s easy to understand why the return of equity market volatility in the first quarter of 2018 caused some consternation for investors. But Dylan Ball, head of European Equity Strategies, Templeton Global Equity Group, is largely unfazed. He outlines how he’s adapted his approach to what he considers to be more normal levels of volatility, incorporating deep stock research and an eye on risk/return dynamics.
Unusually subdued levels of volatility during 2017 possibly lured some investors into a false sense of security. But as precipitous market moves in early February and late March suggested a return to more historically normal levels of volatility, the question for investors now is how to adapt their approach to the new environment.
An Alternative to Derivatives
To help address volatility, some equity funds use the derivatives market to hedge against downturns. For example, an investment manager may use put options to limit the downside, and protect returns. Put options give the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. Buying a put typically represents a bearish view on the security since there’s an expectation for the market price to decline.
But this type of insurance comes at a cost, and while derivatives may offer protection against a decline, they can also erode the potential upside.
We think there’s another way long-term investors can potentially manage volatility: using fundamental earnings analysis to look for those ideas with what we call an asymmetric upside/downside.