It’s fair to say that financial markets are perhaps at their most volatile since the 2008 economic crisis. Not all of this volatility is due to Brexit although naturally, from the perspective of British investors, it is a critical event in the future of the global economy.
It’s all about cause and effect. Every country on the planet enjoys some kind of symbiotic economic relationship with another and when you view the big picture, everything is connected. This means that when there’s an economic, political or even natural shock in one corner of the earth, the ripple effect extends throughout the world’s financial network to affect each and every one of us.
Now, if you’re a Russian oligarch, the government of a small nation or one of the 1% controlling 44.8% of the world’s wealth, any kind of volatility represents huge opportunity. It’s not hard to imagine that if risk was no object and loss was easily sustainable, any one of us would find economic uncertainty a positive boon for wealth-building.
However, back in the real world few of us have the risk appetite to take advantage of anything but the most considered investments. So, how do we navigate uncertainty without losing our shirts?
The Art of Non-Correlated Investment
When there is increased market volatility, investors are prompted to consider alternative or non-correlated investments. Assets that are not correlated to the markets can include everything from private equity and hedge funds to liquid alternative exchange-traded and mutual funds.
When the markets experience sudden drops, most investors hope the value of their investments doesn’t go with them. Non-correlated assets offer the potential for at least some of your assets to stay put when the markets hit the skids.
A great deal about where the best investments are can be determined from the activity of the ultra-wealthy. A 2019 survey of 500 high-net-worth investors published by the Investments and Wealth Institute found that many are turning more to areas such as private equity, real estate and hedge funds.
This is mainly because recent global volatility has created an awareness of the need to diversify, which also applies to average investors with exposure to the markets through their pension funds or stocks and shares.
Certain Risks Come With Each Type of Investment
Property is considered an alternative investment and although it was not correlated to the markets during the tech bubble bursting, the sector was definitely affected during the financial crisis.
A new trend has emerged among institutional investors in the past few years that has seen increased interest in Build to Rent (BTR) and Private Rental Sector (PRS) investment. This is largely considered to be a move to mitigate against falling property prices by shifting to the rental market where there is rapidly growing demand.
- Private equity is another area investors tend to turn to, but how well those funds do is often tied to the global economy. The returns on stock investments were certainly correlated during the financial crisis.
- Hedge funds can also be used to diversify, though they are risky. However, their performance is not better, and in many cases is worse, than the general market.
- Gold and other metals can be used as an inflation hedge, but generally speaking inflation is not a big concern at the current time.
In terms of private equity, investors need to examine the companies underlying their stock pics to make sure they are protected against political and economic risks. Savvy investors are increasingly turning to emerging markets for the most promising opportunities.
One sector that remains unaffected by economic risks is the legal profession. British firms such as Lawthority offering disruptive legal technology that’s at the cutting edge of a rapidly emerging sector are best placed to offer consistent value regardless of economic climate.
Investors also need to carefully consider whether they can handle the limited ability to cash out that comes with some of these investments.
What are the Liquid Alternatives?
Investors may be able to add alternative investment strategies to their portfolios through ETFs or mutual funds that aim to provide protection when markets go down. The advantage of those funds is that they offer daily liquidity. The challenge, however, is picking the winning strategies.
ISAs also provide a good degree of liquidity and they are proving to be a popular tool for diversification in 2019. According to the government’s asset publishing service, around £69 billion was subscribed to Adult ISAs in 2017-18, representing an increase of £7.8 billion compared to 2016-17. It is perhaps interesting to note that the number of ISA subscribers has been rising rapidly since the 2016 EU Referendum.
This increase has been driven by take-up of the Innovative Finance ISA (IFISA), introduced by the government back in April 2016. The IFISA allows individuals to lend money through FCA-regulated and approved peer-to-peer lending or crowdfunding platforms.
Minimising Risk in Non-Correlating Markets
Peer-to-peer, often abbreviated as P2P and also known as crowdfunding is a rapidly growing form of lending that serves three key sectors; personal loans, small business loans and property loans. All three forms of P2P loan are permitted under the new Innovative Finance ISA.
IFISAs provide investors with the opportunity to diversify without taking unnecessary risks. Indeed one of the distinct advantages of ISAs in all their forms is that there is a product to appeal to every risk appetite. Additionally, because crowdfunding platforms cut out the need for banks, borrowers are able to pay reduced fees while paying healthy interest rates to lenders.
As with all investments, it is important to understand how they are likely to play out in a range of scenarios. When an investment directly correlates with a market, it will move in the same direction and so it makes logical sense to know which way that is likely to be.
The safest option of all is to pick investments that have as little correlation to volatility as possible and although you may not get returns to set the world alight, you’ll have a much better chance of holding on to your capital until the dust settles.