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.
average annual returns
of years delivered positive returns
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.
References to Mercer shall be construed to include Mercer LLC and/or its associated companies.
© 2021 Mercer LLC. All rights reserved.
This content may not be modified, sold or otherwise provided, in whole or in part, to any other person or entity without Mercer's prior written permission.
Mercer does not provide tax or legal advice. You should contact your tax advisor, accountant and/or attorney before making any decisions with tax or legal implications.
This does not constitute an offer to purchase or sell any securities.
The findings, ratings and/or opinions expressed herein are the intellectual property of Mercer and are subject to change without notice. They are not intended to convey any guarantees as to the future performance of the investment products, asset classes or capital markets discussed.
For Mercer’s conflict of interest disclosures, contact your Mercer representative or see http://www.mercer.com/conflictsofinterest.
This does not contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances. Mercer provides recommendations based on the particular client's circumstances, investment objectives and needs. As such, investment results will vary and actual results may differ materially.
Information contained herein may have been obtained from a range of third party sources. While the information is believed to be reliable, Mercer has not sought to verify it independently. As such, Mercer makes no representations or warranties as to the accuracy of the information presented and takes no responsibility or liability (including for indirect, consequential, or incidental damages) for any error, omission or inaccuracy in the data supplied by any third party.
Investment management and advisory services for U.S. clients are provided by Mercer Investments LLC (Mercer Investments). Mercer Investments LLC is registered to do business as “Mercer Investment Advisers LLC” in the following states: Arizona, California, Florida, Illinois, Kentucky, New Jersey, North Carolina, Oklahoma, Pennsylvania, Texas, and West Virginia; as “Mercer Investments LLC (Delaware)” in Georgia; as “Mercer Investments LLC of Delaware” in Louisiana; and “Mercer Investments LLC, a limited liability company of Delaware” in Oregon. Mercer Investments LLC is a federally registered investment adviser under the Investment Advisers Act of 1940, as amended. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Mercer Investments’ Form ADV Part 2A & 2B can be obtained by written request directed to: Compliance Department, Mercer Investments, 99 High Street, Boston, MA 02110.
Not all services mentioned are available in all jurisdictions. Please contact your Mercer representative for more information.
Certain regulated services in Europe are provided by Mercer Global Investments Europe Limited and Mercer Limited.
Mercer Global Investments Europe Limited and Mercer Limited are regulated by the Central Bank of Ireland under the European Union (Markets in Financial Instruments) Regulation 2017, as an investment firm. Registered officer: Charlotte House, Charlemont Street, Dublin 2, Ireland. Registered in Ireland No. 416688. Mercer Limited is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 984275. Registered Office: 1 Tower Place West, Tower Place, London EC3R 5BU.
Investment management services for Canadian investors are provided by Mercer Global Investments Canada Limited. Investment consulting services for Canadian investors are provided by Mercer (Canada) Limited.