Market volatility: Grin and Bear it

After a seemingly endless bull run (now in its fifth year!), the recent market volatility will have caused considerable discomfort, if not anxiety. Assuming market volatility is here to stay, what should advisers and their clients be doing to protect and grow their capital?

When nerves are frayed, it becomes difficult to distinguish between objective facts and subjective feelings. We should therefore continually remind clients (and ourselves) of the tried and tested do's and don'ts.

Do's

*Remember your investment objective. If one's investment objective/risk profile implies a particular strategic asset allocation (e.g. a young investor should have significant equity exposure), short- term jitters should not affect the long-term strategy.

*Maintain your strategic asset allocation. If the chosen strategic asset allocation is appropriate, then it should be maintained.

*Fundamentals matter. When considering tactical portfolio adjustments, always try to ascertain whether the fundamental outlook for a given market or asset class has changed significantly, and whether the market's perception of change is correct.

*Seek both alpha and beta. Absolute returns matter in tough times, but so do relative returns in bull markets. This implies having both absolute return products (e.g. inflation-linked or "floor" funds) and index-tracking or index–aware products in a portfolio.

*Have realistic expectations. The phenomenal run-up in South African capital markets over the past four years was triggered by a structural shift to a low-inflation, low-interest rate environment. This shift is now largely over, and investors should accept that returns will be more muted going forward. The long-term return on equity (excluding dividends) is roughly cash plus 6% p.a., and on bonds around half of that. This backdrop should form the basis of one's expectations.

*Get expert help. If your expertise is predominantly in financial planning, there is no shame in outsourcing portfolio management to specialists. To ensure control over asset allocation, use multi-manager products that use specialist building blocks rather than lumping together asset allocation funds. Remember, your role is to ensure appropriate strategic asset allocation, and you need to know what your client's effective exposure to the various asset classes is.

Don'ts

*Don't substitute fear for greed. Just as it is unwise to be reckless when markets are strong, one should not let fear cloud one's investment strategy when markets correct. Capital loss is not the only investment risk – loss of buying power is equally painful in one's old age. It is therefore crucial for people still saving for retirement to aim for inflation-beating returns, which implies taking a long-term view and riding out periods of volatility.

*'Safety' is a relative concept. While it is tempting to seek shelter in cash when other asset classes perform poorly, very few – if any - investors can afford to allow their buying power to be eroded by inflation. Money market funds investments should therefore not be used as the core of one's investment portfolio, unless the investor needs absolute capital certainty and pays little or no tax.

*Don't try and time the market. Experience has shown that market timing is hard to achieve. It is better to make a sound asset allocation decision (and to stick with it) than to try and second-guess the market. Research has shown that being out of the market on just a few of its best days can detract hugely from one's long-term returns.

*Offshore investing is not a zero-sum game. When local markets suffer reverses and the Rand slides, offshore investments invariably come under the spotlight, and a rush for the exits often ensues. Investors should remember that it is not a question of local or offshore, but rather local and offshore – the respective weightings is a function of one's financial needs.