Volatility, Strategic Thinking, and Long-Term Perspective

John Diehl, senior vice president of strategic markets for Hartford Funds, spends a lot of time talking and strategizing with retirement specialist financial advisers; in a sense he is an adviser’s adviser.

Recently, Diehl sat down for a wide ranging conversation with PLANADVISER, following up on a previous interview he offered in February, when U.S. equity market volatility came back onto the scene in a big way. Since then, markets have remained volatile, but asset prices have not in fact dropped precipitously when viewed on a preceding-year basis. Still, as Diehl lays out, volatility remains a top concern for advisers and their plan sponsor clients.  

PLANADVISER: Even with the bouts of equity market volatility we have faced, as of this morning the S&P 500 is still up over 9% for the preceding 12 month period. With that number in mind, have advisers and their clients been keeping the latest bouts of volatility in perspective? Are they remaining strategic and focused on the long-term, or is there evidence of poor portfolio decisions?

John Diehl: When we spoke in February, we were talking about the return of volatility in U.S. equity prices. One of my main comments then was to the effect that, rapid two-way swings in equity prices obviously will not impact people the same way as big negative swings that are not followed almost immediately by a rebound. What we have continued to see since that time is how these strong negative drops in equity prices have almost all been quickly followed up by corrections upward, and so people have not really had enough time to react to the volatility and make many trades.

Investors have taken some comfort in the fact that the volatility all seems to be revolving around a market return of zero or greater for the first half of 2018. So we go down 3%, then up 2%, then down 1%, then up 3%—that sort of thing. Now, I also want to stress that this is not something we can be complacent about. The market can surprise us in either direction, but generally speaking I don’t think the average investor out there is really feeling the sting from this volatility. You think about how strong 2015, 2016 and 2017 were in terms of returns, and that also helps people feel better. One thing that could derail confidence would be if we happen to end a quarter down, say, 5% or 10%, and people saw those numbers reported on their statements. But again, the swings have been too rapid for most people to process or act upon.

One more factor to mention here is that the employment picture has remained quite positive in the last several years, and I believe this has had a strong impact on the sentiment and confidence of investors. Job security seems to be okay right now, the sentiment goes, and there is opportunity out there. So we’re not feeling the double hit of, am I about to lose my job while my portfolio is falling significantly? That’s an entirely different scenario. Right now people are so busy that they might not even have the time to pay attention to daily portfolio moves.

PA: I’d also like you to respond to another figure. The average annualized total return for the S&P 500 index over the past 90 years is 9.8 percent. Yet from 1928 to 2016, only six years finished with a gain within 5% and 10%.

JD: This kind of a statistic can offer another way to think about volatility, as a positive rather than a negative aspect of the markets. But it also shows how challenging it is for advisers to educate their clients about how returns will vary over time and how individual years or even decades can differ from the long-term return average.

One of the things we have done to respond to this challenge is to build out new and creative ways to illustrate the longer-term action of the markets. One presentation that has been very successful is called, ‘Beyond Investment Illusions.’ We find that this terminology of ‘illusions’ really helps people understand some of the signaling that they see around short-term market performance. The main illusion we tackle is that volatility must be feared; as these statistics show, volatility is in fact an opportunity.

Especially when we talk about workplace retirement savings plans, where people will have a consistent flow of new money coming in as they progress through their career, they stand to gain from volatility, not lose. We help people see the danger in sitting on the sidelines or trying to time the markets. Our effort is to try to broaden the perspective of the investor to go look beyond what has happened today or in the last week, and to truly be strategic about their investing.

While we have had a lot of success, I will say it is a challenging effort. People who do not work in this world of retirement investing can have a hard time understanding how volatility can be positive. When they see the market fell 2% in one day, they naturally fear that, and they might want to pull out their money, especially those people who are very near or even within retirement. It’s always going to be hard for advisers to make sure their clients understand the positive aspects of volatility.

PA: Looking forward, do you expect much of the same for the rest of 2018 and beyond? There are many factors to consider in terms of the levers that could influence equity asset prices. Interest rates, for example, are starting to move upward in a more reliable way they have not enjoyed for some time.

JD: That is another difficult aspect of this conversation. It has been some time since institutional investors have had to ask, what happens in an interest rate cycle where rates are gradually increasing? It has just been so long since investors have had to deal with that scenario. Personally, I started working in this area in the late 1980s and early 1990s, and that is really the only time during my career that we were in an interest rate environment where rates were gradually increasing. So helping to educate investors about the basics of what this environment means is going to be a good use of time right now.

It doesn’t mean that it is time to start dumping fixed income. It’s time to learn about the different types of fixed income and why different types of fixed income are important. We have to teach investors about how diversification matters on the fixed income side of the portfolio as much as it matters on the equity side. It is a pressing issue, I should add. I have recently heard investors say to me that they did not understand that their fixed income investments could lose money. They wanted to know, this is a government bond portfolio, and how could its book value drop?

Given that we are generally an active manager of fixed income, we’re really pushing hard to educate investors about the differences between floating rate securities and your core bond holdings. How do these behave in relation to each other and in different environments? How do you spread your exposures across U.S. fixed income, corporate bonds, emerging market fixed income, and all the other flavors? These are important conversations right now, going beyond talking about fixed income as one big lump.