Pending Tariffs: Market Risks and Opportunities…
Ongoing tariff negotiations continue to inject uncertainty into the markets, leaving many unanswered questions. This uncertainty can be unsettling, especially for investors in countries directly impacted by proposed tariffs. Market volatility often follows as investors process the implications of new trade policies.
However, uncertainty is not a novel phenomenon. Having spent over 40 years in the investment industry, I have witnessed multiple periods of market turbulence, each accompanied by both risks and opportunities. Instead of viewing uncertainty solely as a source of volatility, investors should recognize its potential for risk mitigation and alpha generation.
Diversification as a risk mitigation strategy…
Risk mitigation is an immediate concern for investors. Historically, cash and fixed income has provided a stabilizing force against equity risk, with few exceptions. Today, bonds are particularly attractive as we transition to an era of sound money—where interest rates surpass average inflation rates. Given this backdrop, along with stretched equity valuations, maintaining a balanced portfolio is more prudent than it has been in decades.
Periods of market disruption often unlock opportunities. It is crucial to diversify not only across asset classes but also within each asset class. The impact of tariffs will vary across regions, sectors, and companies, and the ripple effects remain uncertain. Investors’ natural inclination toward home bias may prove especially counterproductive in an environment where returns are increasingly dispersed. A globally diversified portfolio, spread across multiple regions and sectors, is best suited to mitigate risks in such conditions.
Leveraging disruption - worth a try?…
Market uncertainty frequently leads to disruption. In theory, this environment should favor active managers, as heightened volatility creates a wider dispersion of returns and, consequently, more opportunities to outperform benchmark indexes.
However, in practice, many managers attempt to “swing for the fences,” taking on excessive risk in pursuit of high returns. True value addition, particularly during disruptive periods, requires skilled, low-cost active managers who make disciplined security selections without feeling pressured to justify high fees.
The impact of costs on risk and returns…
Cost efficiency is another critical factor that influences the risk-return profile for both active and passive investments. The most apparent reason is that costs directly eat into returns—an effect that is more pronounced in bond portfolios than in stock portfolios. Keeping costs low is essential for any investment strategy, but particularly so for fixed income.
A less obvious yet more significant advantage of low costs is that they enable the same expected returns to be achieved with lower risk. Conversely, high-cost managers often feel compelled to take on greater risks to generate returns that surpass their fees, a strategy that can be dangerous in volatile markets.
Skilled, low-cost active managers, on the other hand, can afford to be both prudent and opportunistic. They can focus solely on high-quality investments without the pressure of compensating for excessive fees. This approach ensures that they assume only calculated, strategic risks rather than unnecessary ones.
Uncertainty as a Gateway to Opportunity
Throughout my four decades in the investment industry, a few enduring principles have remained constant. One of the most important is this: every downturn, disruption, or period of uncertainty has also unlocked opportunities. Rather than fearing uncertainty, investors should embrace it as a catalyst for strategic positioning, risk mitigation, and potential market outperformance.
Rick Maggi CFP, Financial Advisor (Perth), Westmount Financial