As volatility has become the new normal, risk management is as important as asset allocation and stock selection in the investment process, says Marthinus van der Nest, head of Amplify Investment Partners.
“The volatility in markets we have experienced this year has brought to the fore the focus on risk management,” he says. The ongoing war in Ukraine, China’s economic slowdown, ongoing supply chain issues and coordinated monetary policy tightening globally are all elevating risk and volatility.
As Amplify employs a range of independent managers with different investment processes and fund-specific mandates, there is no one size fits all approach when it comes to risk management.
However, most of Amplify’s managers are focused on capturing as much upside as possible while protecting on the downside by managing risk. There is, among all of them, a significant emphasis on diversification and not positioning a portfolio for a single outcome. Equally important are position sizes, and its managers are avoiding taking large bets, given the heightened level of uncertainty.
“When looking at securities, our managers look for those that offer a significant degree of safety. They will typically invest in securities where they believe there is greater upside potential than there is drawdown risk. Where securities offer significant upside potential, but also come with greater risk, they will either avoid them altogether or limit their exposure by taking a smaller position,” says Van der Nest.
With many bonds yields currently north of 11%, bonds are offering a good real return at relatively low levels of risk. Given current inflation, investors are earning a real return of 4% or greater, providing a significant buffer to investors should yields sell off further. “Where we sit now, those yields are obviously very attractive,” Van der Nest says.
Another risk management technique used advantageously in Amplify’s hedge funds is the ability to short certain instruments during periods of high volatility, enabling them to have a low net exposure to the market when less risk is required to protect capital. Given the levels of risk in markets currently, there has been increasing interest and a lot more inflows into Amplify’s hedge funds to mitigate risk and to generate returns as “a consequence of people looking for alternative sources of alpha,” says Van der Nest.
He emphasises that there are significant geopolitical risks currently, and markets are down as a result. “There are certainly opportunities at the moment in terms of assets that have sold off, especially looking at the US tech sector, so there are opportunities out there, but obviously also risks of earnings downgrades, central banks not being able to bring inflation under control, interest rates having to stay higher for longer.”
Van der Nest expressed some concern about mortgages in the US, where the move from fixed to floating rates on many bondholders is resulting in people spending more on servicing bonds, resulting in a strain on consumers.
Ultimately, a lot of risk mitigation comes down to the agility and skill of fund managers, which is why Amplify’s strategy of employing independent flexible boutique managers had paid off during the last few years as they are more able than large managers to move quickly, act decisively and manage risk during volatility.
*SCI – Sanlam Collective Investments