When it comes to political risk, diversification is key for automated passive investment portfolios.
As uncertainty lingers about North Korea’s nuclear threats, questions remain about the impact of Brexit and political unrest around the world on stock market volatility. It’s a test for all investors including passive funds and a new breed of digital wealth managers.
How do ‘robo-advice’ platforms, who predominately invest in Exchange Traded Funds (ETFs) and use automated technology to monitor and change investors portfolios, respond when faced with a political uncertainty like nuclear war in North Korea?
Will Trout, head of wealth management at Celent, says that if large enough, a political catastrophe like an escalation in the stand off with North Korea could be a test for robo-advice firms.
“Such an event would have serious impact on markets worldwide, and thus on passive (market tracking) securities like ETFs,” he said.
But that doesn’t mean robo-advisers or investors should worry. Most political events are just “noise” and the real market moving events are things like central bank decisions on interest rates, Trout adds. It’s difficult to isolate political risk from other factors and the best way for robo-advice firms to mitigate risky events is to watch for market signals, he says.
“By far the most reasonable way for robos (and other investment advisors) is to gauge market signals that reflect emerging risk, or at least, reflect a perception of increased risk, in the market,” he said.
One of the ways that platforms mitigate risk is by diversifying portfolios, said Oliver Smith, portfolio manager at IG.
“There is always a risk in any political event,” he said, “Because of the way that we invest, with so much diversification, there would hardly be any exposure to what happens in North Korea.”
His firm uses BlackRock’s ETFs and asset allocation models focused on long-term investing and like a lot of other digital wealth management firms, they track and rebalance the portfolios periodically.
Before the Brexit vote, BlackRock increased its fixed income duration, which helped increase returns despite the fall in sterling, Smith said. IG is decreasing its Brexit risk with a decent exposure to the FTSE 100, which have about 70 per cent of exposure overseas. For there to be real exposure to Brexit, you would have to invest in small and mid-cap markets, which doesn’t work well in an ETF format, he said.
Tony Vail, chief innovation officer at B2B robo-adviser Wealth Wizards, said the company would consider excluding particular exposures under exceptional circumstances but did not give details of what those circumstances would be.
Portfolios at Wealth Wizards are diversified across international markets to avoid exposure to one sector or area.
“It's important initially to understand the individual’s desire, capability and need to take risk with their investments,” Vail said.
At ETFmatic, a digital wealth platform that operates in 32 different European countries, users select their asset allocation based on their long term needs. “Black swan” events are handled by a risk management process, said Johann Bornman, director of product at ETFmatic.
A pure robo-adviser does not take an active market position or investment view, Bornman says. While the firm doesn’t hedge against political events at the moment, it’s a possibility in the future, he said.
“We are an investment firm however, we aim to offer different styles of portfolio management to suit everyone's needs,” Bornman said.
At Scalable Capital, investments are based purely on quantitative analysis and data, says Adam French, co-founder and CEO at Scalable Capital. Potential threats, such as political events, are reflected through market volatility, he added.
“If events are relevant for investors, the markets typically react to them, which means an increase in volatility,” French said. “Only "out of the blue" (i.e., real black swan) events like 9/11 cannot possibly be preceded by increasing market risk.”
His firm responded to market volatility in the market ahead of Brexit by shifting portfolios into a conservative mix. Ahead of the US election, allocations were moved to emerging market bonds and stock markets outside of the US, French said.
“While speculating on political decisions and macroeconomic indicators plays no role in our investment model, their impact on the risk of the different asset classes does,” he added.
This article first appeared on www.roboadvicenews.com