Divergent Central Banks And The Importance Of Risk Mitigation

Global monetary policy continues to be a major driver of market conditions. The latest development: The European Central Bank’s decision last week to cut interest rates and expand its asset-purchase program in an effort to stimulate eurozone growth and inflation.

This surprise move by the ECB highlights the divergence in monetary policy among major central banks:

  • In the U.S, investors see the Fed as more likely to tighten monetary policy by raising short-term rates than to ease.
  • In contrast, the European and Japanese central banks are implementing aggressive monetary easing policies.
  • Meanwhile, it remains unclear what the next move will be for China’s central bank.

Divergent Central Banks It’s not surprising that equity markets have experienced significant volatility given the continued questions about global economic growth, and the central banks’ responses to that uncertainty. As the charts showing the volatility of the S&P 500 and of emerging markets below reveal, we are in a different volatility regime today than we have been for the last few years.

Although volatility has subsided recently, we expect volatility to remain structurally higher as investors continue to wrestle with considerable uncertainty.

Protecting wealth—and capturing gains—in an uncertain environment

Horizon’s active risk mitigation strategy, Risk Assist®, has enabled investors to avoid some of 2016’s most extreme downside volatility. 

Many accounts using Risk Assist started the year with a 30% hedged global equity position. That hedged position was increased to a maximum of 70% as volatility rose during the first five to six weeks of the year. As global markets began to show signs of stabilizing near the end of February, the hedging levels of these same Risk Assist accounts was reduced, and stood at 30% as of March 14th.

The benefits of this active and global approach to risk mitigation can also be seen in the recent performance of the Horizon Active Risk Assist Fund, which has exhibited just 60% of the volatility of the MSCI All Country World Index (ACWI) year-to-date. Such lower volatility can be instrumental in helping clients maintain their global equity bias during challenging and uncertain market environments (such as when central banks make unexpected policy decisions).

In addition, the gradual reduction in Risk Assist Fund’s hedged position that began in late February has helped the Fund benefit from the global equity markets’ recent positive returns—as evidenced by the fact that the Fund has captured approximately 80% of the S&P 500’s upside so far in March, with only 68% of the volatility.

 

Categories: Market Notes
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