UBS House View Weekly
The value of staying invested
Realized volatility in stock markets has increased over the past month from extraordinarily low levels over the summer. As the US presidential election, US rate hikes, and other potentially disruptive events near, investors should consider how they might react if higher volatility and uncertainty arise.
Typically, when equity markets start to correct, investors’ gut instinct is to sell their most liquid positions to raise cash and await better entry points. Yet this emotion-driven reaction often means liquidating at inopportune times and prices, and – more damaging – failing to get reinvested quickly enough. “Missing out” can cost investors and undermine a long-term strategic approach.
Private markets provide some useful lessons about staying invested during periods of market turbulence. These illiquid investments require capital commitments of 10 or more years. Investors’ only option for liquidity is to sell their stakes on the secondary market, often at a substantial discount to fair value in volatile markets. This structural illiquidity tends to keep investors invested in private markets, avoiding the potential for emotion-driven missteps.
What can private markets teach us about staying invested during market turbulence?
- Portfolios can benefit from less frequent marking to market. Private markets exhibit lower drawdowns during market corrections compared to public markets. This structural advantage results from less frequent valuations (quarterly), which lower reported volatility and improve portfolios’ risk-adjusted returns. Reacting to these interim valuations is less relevant given the truly long-term nature of these investments; long-term oriented investors can apply a similar approach to liquid securities in markets where fear impacts pricing.
- Maintain long-term focus and avoid emotion-driven selling. The advantage of private markets illiquidity is that these structures hold investors to their original long-term perspective, forcing them to stay invested through difficult market conditions. This prevents selling at depressed valuations and enables investors to benefit from long-term returns. Investors can apply this same approach across their listed portfolios as well to avoid emotion-driven missteps, making tactical adjustments but maintaining the long-term strategic core intact.
- A long-term mindset provides the flexibility to be opportunistic. Private markets funds with dry powder and long lockups can take a long-term view on value and capitalize on dislocations, while other investors are paralyzed by short-term fears. Similarly, long-term oriented investors should take advantage of their time horizon and be willing to invest in volatile public markets where fundamentals justify the long-term case.
Private markets can help enable investors to take emotions out of their investment decisions, and thus act in a way that is better matched to their intended portfolio timeframe. Even though equities and bonds can easily be sold, investors that are focused on long-term returns should self-impose similar mental “illiquidity constraints” in volatile markets and avoid making suboptimal emotion-driven decisions. Investors should limit themselves to rational tactical adjustments during turbulent times, or alternatively implement ongoing portfolio hedges that can alleviate the fear of significant drawdowns. Either way, the objective should be to avoid being emotionally reactive and instead remain invested for the long term, just as in private markets (even though the structural constraint is not the same).
Global Chief Investment Officer
Head of Impact Investing and Private Markets
Global Investment Office
We can all take a behavioral cue from private markets in times of market turbulence. Even though investors can sell their liquid securities, they should instead self-impose a mental “illiquidity constraint” and keep their long-term portfolio framework and objectives foremost in mind. Fundamental or signal-driven tactical adjustments make sense in this context,
but emotion-driven selling can diminish long-term investor returns and should be avoided. As historical private market returns illustrate, investors with the fortitude to maintain a long-term mindset even in turbulent times should be rewarded over the long term.