Risks of switching options during market volatility
Markets have reacted strongly to the coronavirus and central banks have cut interest rates. In this video, Chief Investment Officer Damian Graham talks about what's causing markets to be so volatile now, and why it’s important to focus on the long term when thinking about your super and retirement.
- What's happening?
- The risks of switching options
- How do we manage our investments?
- Why are markets so volatile now?
It’s been a wild ride for share markets in Australia and around the world these past few weeks. The recent increase in market volatility has created a challenging environment for investors and the wider superannuation industry.
Markets like certainty, but the spread of the coronavirus has created sudden and significant uncertainty, not to mention a lot of emotion. A supply dispute between the Organisation of the Petroleum Exporting Countries (OPEC) and Russia has also added to this uncertainty and volatility to oil prices.
The risks of switching options
Volatility is expected to remain a prominent feature of markets in the next few weeks and months. Investor sentiment is constantly shifting as more becomes known about coronavirus and its potential impact on economies.
It can be tempting to consider switching investments during times of market volatility. Headlines can be distracting, and at times unsettling. You might wonder whether you should take action or simply sit tight, which might feel counterintuitive.
But switching to cash when markets are down comes with the risk of locking in losses. While you remain invested, the impact of market moves are paper losses that can be recouped if markets rebound. Conversely, switching to cash means selling out of stocks and crystallising the market falls that have already occurred. Timing markets is notoriously difficult, and history shows that most investors don’t buy back in time to benefit from any rebound in markets.
It’s also important to remember that super is a long-term investment. Over long horizons, cash typically does not keep pace with the cost of living (known as inflation). This means that for every $10 you save, you’ll be able to buy less with it in the future than you can now. This is a big issue because the primary aim of saving for your retirement is to be able to maintain your lifestyle once you retire.
While cash investments experience less short-term risk (volatility), in the context of superannuation savings, it carries a high level of long-term risk.
Taking a long-term view can also help you benefit from the power of compounding. That’s the snowball effect that happens when you receive returns on your earnings, as well as on your original investments. It’s important to remember that while the stock market might jump around or enter a prolonged downturn, history has shown that the markets grow over the long term and eventually surpass their previous highs.
How do we manage our investments?
We manage our investments to take account of short-term risks. But we also have an overarching, longer-term risk-adjusted strategy that aims to maximise your long-term savings. With a strong and skilled investment team of over 70 people, we’re closely monitoring markets and ready to take advantage of investment opportunities as they arise.
Diversification (i.e. spreading your money across arrange of investments) helps to cushion the impact of market falls on our pre-mixed options.
Is my super safe?
First State Super is one of the largest super funds in the country, with over $100 billion invested in a diversified range of asset classes.
We regularly monitor and stress test fund liquidity (how much cash we have). Currently, we’re in a strong and stable liquidity position and are well prepared to navigate through these difficult market conditions.
Our member base is diverse, with large contributions from the NSW public and health sectors, and we don’t anticipate any significant reduction in inflows.
Why are markets so volatile now?
Coronavirus initially created a supply shock from China but is now having a much larger impact on global demand. Many countries are now closing borders and schools, and cancelling sporting events and large public gatherings, to limit the spread of the disease. As consumption stops and we hit ‘pause’ on economic activity, there’s a rapidly growing downside risk to global growth.
It’s now clear that economic disruptions and market volatility will persist for some time. The key question is, will global growth recover with policy stimulus, or could this volatility become self-perpetuating and result in a deep recession?
To help ensure that the economy and markets recover once the pandemic passes, global central banks are now acting in a coordinated fashion. Many are cutting rates to zero (or very close to it) and announcing measures to promote the movement of cash and continued economic activity.
For example, on Thursday 19 March 2020, the RBA cut its cash rate to 0.25% and committed to quantitative easing actions to keep financial markets functioning and ensure banks are incentivised to lend to businesses. This is the first coordinated action of its kind since the Global Financial Crisis.
With rates already at very low levels, markets are looking for more and are focused on the need for coordinated fiscal stimulus (Government spending) to support economies through this difficult period. We’ve now seen numerous announcements to support household incomes, maintain employment and other cash flow support for businesses.
The US Government has announced a package of support worth approximately 5% of the GDP, while the New Zealand announced measures worth about 4% of the NZ GDP. The Australian Government announced a fiscal support package of $17bn (1.2% GDP) and further announcements are expected.
With the coronavirus affecting key economic sectors, we’ll likely see falls in Australia’s GDP, exports, retail and consumer confidence figures in coming months. This will probably result in scary headlines and a lot of noise. But the market tends to be forward looking, and may start to look through data, once the outlook starts improving. This is one of the reasons it’s so difficult to time the market.
If you need to generate income from your assets to support your retirement, your planner can help you structure your portfolio so that you can reduce the risk of having to sell when markets are down. This will help you ride out periods of market volatility.