One year on from the widespread market volatility caused by Covid-19, it is worth re-visiting what history tells us about equity market volatility and understanding how we can prepare for it when it arrives again as part of the natural market cycle.
Average returns numbers alone can hide the true journey that investors must take in order to harvest equity risk premium over the long term. As the old adage goes, never forget the six-foot-tall person who drowned crossing the stream that was four feet deep on average. 2020 was the perfect example of this. While the MSCI World finished the year +16%, to achieve this many investors had to endure a stomach wrenching 20%+ drawdown through March.
Large drawdowns are common in various equity asset classes. However, smart portfolio construction can help overcome these issues, creating an overall portfolio that benefits from the growth potential of equities while keeping a clear eye on risk. To delve deeper into the history of equity market volatility, Figure 1 below is an analysis of the MSCI World from 1970 to 2020, displaying calendar year returns and the intra-year drawdowns investors had to endure each year.
+9%
average annual returns
75%
of years delivered positive returns
41%
of years had drawdowns >10%
Figure 1: MSCI World calendar year returns and intra-year declines (1970-2020, in USD terms, monthly data). Source: Databank, MSCI World. Based on monthly USD returns for the MSCI World from 1970 to 2020. Annual returns reflected in green/pink bars. Intra-year drawdown reflected by blue markers (uses monthly data). For illustrative purposes only.
The average historical returns of +9% per annum over this 51 year period are attractive and approximately 75% of years posted positive returns. However, for a long-term investor to achieve these returns, they would have had to undergo significant intra-year volatility and drawdowns as you can see from the blue markers above. In fact, the MSCI World experienced greater than 10% drawdowns in 21 of 51 years and greater than 20% drawdowns in 9 of 51 years. As a result, understanding what to expect from equity market volatility can help you prepare your portfolio ahead of time. Here are three simple steps you can take:
1. Build effective diversification
Equities are a key growth driver within your investing toolkit. However, understanding equity volatility and building a diversified portfolio that incorporates a wide range of risk and return drivers is key to improving your outcomes over the long term. Mercer seeks to build robust portfolios with effective diversification across assets classes, managers and incorporates allocations to help provide downside protection. Smart portfolio construction can help enable a smoother journey when increased equity volatility appears.
For illustrative purposes only.
2. Use a “Governance Advantage” to seize opportunities
Market volatility can be uncomfortable. What we call a “Governance Advantage” can help you remain confident about your investments – even in the toughest market conditions – and rest assured that your portfolio is in professional hands. Our robust governance framework is delivered through a tailored approach that is designed to reduce complexity, respond quickly, capturing market opportunities and managing costs. In the uncertain depths of a market crisis, investors with a governance advantage should be ready and positioned to capitalise on opportunities.
3. Reach out to Mercer’s Investment Solutions team
Mercer’s Investment Solutions team is ready to help you prepare your portfolio for market volatility, helping you to see through short-term noise and focus on your longer-term financial goals.
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