"It is important to note that, at the individual level, all market participants, whether they are less knowledgeable individual investors or experienced money managers, may act irrationally." – CFA Institute
Anyone watching the news today understands there are a number of crosscurrents feeding into global stock markets right now.
Themes of inflation, interest rates, geopolitical tensions, conflict in Europe – and who could forget our old friend COVID-19 – have rocked global equity investors in 2022.
The benchmark S&P/ASX 200 Index (ASX: XJO) has slipped 4.3% into the red so far this year, even after staging a small recovery this past week or so. Sector-specific and thematic indices are down even further, as seen on the chart below.
With these undertones driving market volatility, it's no wonder that some investors are feeling the pressure on their portfolios. Gone are the days of 'SWAN' (sleep well at night) investments in the current macro-climate.
As the Chartered Financial Analyst Institute points out, everyone is susceptible to these kinds of emotions. In essence, it's what separates us as humans from the computers and bots that also trade the markets.
But what to do in these uncertain times to protect capital, ensure liquidity, and cover the significant downside events?
Consider high-quality shares as an 'inherent' risk control
First of all – life comes with a deal of uncertainty. No one knows the future and those who pretend to are shown the door time and time again (especially in finance).
Whether it's making predictions of financial markets under starlight using 'financial astrology' or even complex econometric, statistical models, there is no human, computer, or company that will get it right every time.
Hence, one has to adopt a systematic approach in embracing the unknown and clearly distinguish between what is uncertainty and what is risk, according to Kauri Asset Management's George Wong.
One particular tried and tested mantra that factors in both risk and reward is to focus on high-quality shares, Wong wrote on Livewire last week.
"Investing in high-quality companies is an inherent way to mitigate downside risk during uncertain periods, and often presents a low-risk, high-reward situation," he said.
"The risk of irreversible loss of capital for high-quality companies with strong fundamentals is low. By nature, these companies tend to be resilient and often bounce back stronger than before."
Risk and uncertainty are two separate things
High-quality companies have shown to be more resilient in times of market sensitivity and are less 'jittery' in times of volatility, Wong says.
And that's precisely how he says to navigate the investment landscape in times of uncertainty – by focusing on the fundamentals of a business and capitalising on "rare chances to add high quality stocks to your portfolio".
However, if one is afraid of uncertainty, these opportunities may pass, Wong says. This, he says, is why it's so important to separate uncertainty and risk.
One way in which to achieve this is to prioritise a long-term investment horizon and focus on a systematic approach to investing – especially for those in their younger years.
This can help to cancel short-term noise and encourage investors to remain confident in their investment convictions which should be based on fundamentals anyway, Wong reckons.
"As long as we have a system with which we can prepare ourselves mentally in dealing with uncertainty, and methodically evaluate investment opportunities, then uncertainty will afford us more opportunities to become successful investors," the financial advisor remarked.
"Keep in mind, if businesses like banks and insurers can establish highly profitable operations on the very premise of accepting uncertainty, we also have the same opportunity."
