Finding investment opportunities in times of volatility 

It comes down to the basic principle of having a good plan in place, which includes well-defined policies, procedures, and the right governance. Receiving new information, assessing and evaluating it in a disciplined and thoughtful way, and then making decisions, communicating them effectively, and implementing them promptly is no easy task, especially when the ground seems to be shifting beneath our feet.

In this issue, we will focus on how Canadian investors can best prepare to navigate volatility, by diving into the data we have been receiving from the market. We are very fortunate at Mercer to have over 200 research specialists worldwide who engage regularly with the thousands of asset managers that we work with and review in both public and private markets. This provides us with unique on-the-ground insights from a practitioner’s perspective, which we can then leverage when helping our clients build better portfolios.

We summarize below some of our initial findings across both public equity, fixed income and private market strategies. 

The landscape for active equity managers has been complex, particularly in global equity markets. The environment has been particularly challenging for active global large cap equity managers, with 70 per cent of global equity strategies having underperformed their benchmark indexes in 2024, and nearly two-thirds having underperformed over three- and five-year periods.

This underperformance is often attributed to being underweighted to the Magnificent Seven – the US-based technology and artificial intelligence focused companies that have driven up global markets. This has left many active equity managers with a difficult choice: further emphasise this concentrated group of holdings or seek out other diversifying opportunities globally. With the benefit of hindsight, diversification has been a headwind to performance during the past several years.

Despite the challenges faced in global markets, Q1 2025 appeared to have shown early signs of improvement for active equity management. For example, from a global large cap equity perspective, the median manager slightly outperformed the benchmark index, which compared to last year’s results is an encouraging sign of a turnaround. This trend is tied to markets having shifted some of their attention from the Magnificent Seven and instead focusing on fundamentals, ultimately creating an environment where active equity managers can identify other opportunities, including attractive valuations and strong earnings potential. 

 

If history is any indication of what is to come, periods of extreme concentration eventually unwind. The question is not if, but when. In this time of uncertainty, closer interactions and review of managers should be encouraged to support results that are consistent with expectations given the managers’ philosophy and style. Such enhanced monitoring will help investors fulfill their oversight responsibilities in this evolving landscape.

We also find that volatility is helping surface those strategies that employ a disciplined approach to active equity management. With potentially higher interest rates, markets appears to have begun shifting their attention with a renewed focus on valuation – a benefit for value-oriented managers whose strengths lie in identifying opportunities in diverse markets and with a goal of ensuring portfolios are not over reliant on a handful of companies.

This shift, however, underscores some of the trade-offs managers are facing. They must balance the desire to mitigate tracking error and remain close to the benchmark’s performance with the need to make bolder decisions in the pursuit of greater returns, which may result in higher tracking error and increased variability of returns against the benchmark. With this in mind, investors should assess their risk tolerance and continue to consider allocations to a diverse set of return drivers, sectors and regions when determining which approach to active risk-taking best aligns to their investment goals. Setting expectations ahead of time based on sound portfolio construction principles will be of great value when inevitable periods of unexpected turbulence occur.

From a fixed income perspective, manager discussions in Canada have expanded from the debate around the trajectory of interest rates, which now appears more unpredictable than it was a few months ago, to include growing factors like tariffs that contribute to economic uncertainty. 

There is a “tug-of-war” between short-term inflation concerns and longer-term growth worries in Canada, causing managers to be more cautious. They are positioning their portfolios with a ‘steepening bias’, betting on the yield curve steepening (i.e., short-term rates falling more than long-term rates). 

Similarly, the credit market seemed optimistic at the beginning of the year, with a strong demand for higher-yielding investments. However, tariffs and other economic concerns have facilitated the credit market to become more cautious and selective. Managers are now being nimble and more tactical, carefully choosing investments and avoiding potential risk.

While public markets investments continue to represent the largest share of our client portfolios, the dynamics within private markets also provide interesting perspectives and opportunities unique to unlisted investments. We share below some observations stemming from our conversations with private markets managers and investors. 

Many private markets managers have reported that they are continuing to experience a slowdown in deal-making activity in Q1 2025, contrary to their previous expectations of a more favourable environment to emerge as economic indicators and interest rates normalized. Buyers and sellers are anticipating the impact of potential tariffs and their second-order effects on supply chains, even though concerns around economic fundamentals do not appear to be severe at this stage. 

That said, there are some areas where uncertainties are contributing to investors widening their aperture and adjusting their focus. As an example, some investors have started to shift their approach to private debt, diversifying beyond traditional lending strategies to other niche strategies, such as asset-backed strategies and asset-based finance, whose risk-reward and cash flow profiles may be more attractive in the current environment. 

While managers are seeking out opportunities and innovative ways to enhance returns on more resilient credits in this volatile market, they are also mindful of potential ‘contagion risks’ if economic challenges are not adequately addressed.

In a slower deal-making environment, managers are also looking for ways to provide liquidity and deploy capital strategically in private equity strategies more broadly. Scarcity of capital and a slower fundraising environment has highlighted attractive opportunities in the mid-market, secondary market, as well as in the co-investment space as managers seek to attract additional equity capital to finance transactions. Another opportunity is through trigger funds, which allow you to commit capital today but only draw capital when specific negative events occur.

Ultimately, well-built private market portfolios are designed to be resilient through market cycles. For success in the long-term, it is important for investors to stay engaged with their portfolios, actively monitoring them to add investments and capitalize on opportunities that emerge from periods of uncertainty and volatility. 

In today’s volatile market, Canadian investors need to be strategic, disciplined and adaptable, actively seeking out diverse opportunities to position themselves for future success.

What you need to know

• Plan – don’t panic: Plan for different market scenarios, recognizing there is no ‘one size fits all’ response or approach
• Communicate: Monitor market conditions and maintain open lines of communication with your managers to understand their market navigation strategies. 
• Be disciplined: Adhere to established investment policies, governance structures and decision-making processes during volatile times, ensuring you have procedures in place for evaluating new information. Consider conducting a stress test of your asset allocation to ensure you have the necessary liquidity and able to withstand potential risks. 
• Prioritize: Focus on the most critical information and geopolitical risks impacting your investments, avoiding making impulsive decisions based on daily market news. 
• Understand your time frame and risk tolerance: Determine the appropriate investment timeframe and align investment decisions with your risk tolerance, focusing on learning from current market events rather than reacting impulsively.

As you face the challenges and opportunities ahead, we hope this issue of Compound Interests has provided you with the knowledge you need to navigate today’s volatile market with greater confidence.

¹ Source: Webinar Navigating volatility: Strategic insights for Canadian investors, May 8th 2025