14 February, 2018

Stock Market Volatility: How Balanced is Your Portfolio?

Stock Market Volatility: How Balanced is Your Portfolio?

The FTSE 100 plummeted, down more than 300 points by close of the 6th February. This was half the points drop suffered by the Dow Jones, and Asian markets experienced a similar drop.

The Guardian Business live updates page reported ‘Stock market turmoil’ which preceded ‘rolling world stock sell off runs to $4 trillion’.

Industry commentators have questioned inflated valuations in equity markets signalling a sell off and possible market correction for some time. However, this was not the reason for the correction. Since 2008, generally the large global economies have grown at an increasing rate. In part, monetary policy of low interest rates and quantitative easing has stimulated this growth. With the major economies seemingly back on track, investors are questioning how long monetary policy which favours growth will last? Will the value of their assets be the same in a new monetary policy environment?

Low interest rates encourage spending by lowering the cost of borrowing. Increasing interest rates increases the cost of capital which hurts the bottom line of big businesses and the monthly bills of people. On the flip side, too much spending causes inflation. In November, the central Bank of England rose interest rates to 0.5%, signalling the start of a series of rate rises.

Discussing rate rises on the 8th of February, the Governor of the Bank of England, Mark Carney commented:

‘Somewhat sooner and to a somewhat greater extent’

The recent volatility in the stock markets has widely been accepted as a concern over the consequences of rising interest rates and a general move away from quantitative easing. Non-intuitively, indications of a rate rise result in bond prices dropping, as the coupon of tomorrow is thought to be greater than the coupon of the bond purchased today.  This results in a sell off. With investors dropping out of the bond market, equity holders further got nervous causing a sell off. All in all, a lot of changing sentiment caused by monetary policy, seemingly at a distance to the value of the underlying asset has caused this volatility.

Typically, you would expect equity markets to rise, when bond prices fall, i.e, more people moving into risky stocks, away from more secure stocks. Balancing bond and equity holdings is a pillar of portfolio construction in part due to this reason. However, when markets are under stress both bonds and equities follow a similar trend, both are sold, resulting in a high degree of correlation. Simply constructing a portfolio of bonds and equities may not be enough to build a diversified portfolio.

In an uncertain market, it is good to have a well-diversified portfolio across different geographies, sectors and asset classes. Multi-asset diversification into investments that are not correlated is one of the core concepts of modern portfolio construction. Peer to peer investing has a very low correlation relative to equity and bond markets, which is a key benefit to retail investors.

When feeling the pressure of volatile traditional markets, P2P investments with their stable, predictable returns can look increasingly attractive. Lending to individuals through online platforms allows investors to gain interest payments which, if diversified across a large number of borrowers, can be consistent and predictable. Loans are not traded on exchanges and therefore shielded from stock market volatility.

P2P investing can, however, be risky and the market is complicated. That is why we created the Orca Investment Platform, providing investors with an easy, diversified access point to the attractive returns of the P2P market. Investors are offered one of three portfolios which change depending on the level of investment, whilst spreading risk across the P2P market.

Particularly, in light of recent market volatility, the Orca product is a solution which creates multi-asset diversification at ease. We’d welcome any comments or feedback on the product, please email ‘[email protected]’.