From risk to opportunity: the importance of financial advice

Bad news travels fast. The events of the past week are not giving investors much to be cheerful about: from sky-high inflation (breaking records in the USA and the Eurozone), to expected interest rate hikes in Europe (Lagarde recently stated that a hawkish policy may be pursued from July onwards) and growth forecasts that have been revised downwards due to a variety of risks (although the most recent Economic and Sector Outlook Report by MAPFRE Economics forecasts growth of 4.2% for the Spanish economy).

All these factors are being taken into consideration by professionals as they make investment decisions. However, they are not the only issues that are stirring up the market: Alberto Matellán, head economist at MAPFRE Inversión, listed other core elements at the ‘Consultancy: from risk to opportunity’ event (organized by MAPFRE) that are required to understand the context that investors must navigate.

• • Gradual withdrawal of liquidity

The United States has already announced that it will start to reduce its balance sheet starting this month (by around 95 billion dollars per month, according to the most recent minutes from the Federal Reserve). The ECB, in turn, is keeping an eye on how prices evolve and will take measures to control its balance sheet accordingly. However, it has already started to make a move: it started to withdraw liquidity in April, 40 billion euros worth, and the institution is expected to keep it at 20 billion in June.

Alberto Matellán explains that the central banks “said that the withdrawal was necessary because there was too much money on the market. They have already started the process, but only time will tell whether it is too late. The whole process shouldn’t take more than two or three months.” In the expert’s opinion, it's a classic case of “the boy who cried wolf,” given that these measures probably should have been taken sooner. “Nobody paid attention when the wolf came along and he’s now gobbling up our savings,” he added.

One of the most interesting details related to these liquidity issues is the money that was printed to contain drops in activity during the pandemic. “Around 80% of dollars and euros in circulation were printed over the past two years. This has only happened twice before in history, and both times it resulted in the economy crashing, although the situation is quite different now,” asserted the expert.

Forecasts predict that “inflation rates will start to level off after summer on account of the base effect (twelve months ago inflation had already started to rise). Fixed income (which was hit hard in recent weeks) will once again be a safe-haven asset.”

• • Significant uncertainty

The war in Ukraine has exacerbated many of the risks already affecting the globe. This has led to levels of market volatility that had not been seen since the start of the pandemic or the 2008 financial crisis. In this sense the VIX (the S&P500 volatility reference index) has demonstrated that investing during these difficult times is no mean feat.

However, can uncertainty be accurately measured? “Not really,” responds the head economist. “But it is clearly dragging down growth, meaning that consultancy, and having a professional figure who serves as a guide, is important.”

• • Energy transition

The market consensus recognizes that the energy transition is a step that economies will have to take sooner or later. The climate crisis is becoming an increasingly important issue and the switch to clean energy is inevitable.

However, the commodity crisis, supply chain disruption and the resulting problems associated with energy prices (heightened since the invasion of Ukraine on February 24), have brought progress to a standstill. “When the pandemic was happening, a lot of noise was made about the sustainable, green economy. But during this crisis people’s perspectives have started to shift back,” recognizes the economist. Carrying out a rapid energy transition, over such a short period of time, could entail significant costs for economies and families (and even more so given the current situation).

The keys for creating a consistent portfolio

These factors are not always taken into consideration when creating a portfolio. It’s become evident, for example, that fixed income funds, which were once a prudent choice, have started losing out to variable income products. However, as asserted by Daniel Sancho, head of investment at MAPFRE Gestión Patrimonial, “there are always going to be short-term risks. But where there is risk, there is usually an opportunity.”

When drawing up consistent portfolios, one must also have a clear idea of the investment time horizon. The expert from MGP asserts that “in the short term, there are imbalances; however, as time passes, these disparities diminish.” During this period, “it’s managers who need to be playing down the short-term noise and looking for opportunities. And advisers have to make sure that customers relativize this noise too,” he adds.

He also explains that emotions can affect investment decisions or portfolio composition: “It is the greatest risk of all. That's why the customer must be advised throughout the entire process , filtering information through the lens of our expert knowledge.”

Therefore, Ismael García Puente, investment manager and fund selector at MGP, believes that there are six keys to creating a consistent fund portfolio, that make it possible to protect against bumps in the market and obtain returns.

1. The importance of “Asset allocation”

Significant focus is placed on the selection of funds to the point that 80% of a portfolio's returns depend on the correct allocation of assets. “If we want to look for greater returns, we need to take on greater risks,” says Ismael García Puente.

2. Weights in the portfolio

This aspect is mainly reliant on the distribution of assets and the risk/return relationship for each asset type, bearing in mind which assets play the biggest role in the portfolio.

3. Number of funds

“There is no magic number,” as Ismael explains, although “increasing the number of funds when not necessary can have an adverse effect” (such as Alpha dilution or increase in costs). “A higher number of funds does not translate to greater diversification,” he adds.

4. Limiting losses

“People love making gains but hate making losses”. More precisely, when X gains generate a utility of Y, X losses generate a negative utility of Y multiplied by 2.5. The psychological value, the way in which the investor looks at gains/losses, in this sense, plays a significant role.

5. Forget about ‘market timing’

“Investing is boring,” people say. But keeping an eye on daily market fluctuations can lead investors to make undesirable changes to portfolios, with a long-term outlook taking priority over immediate returns. The average daily returns of the S&P 500 over the past 30 years are 0.03% and the MSCI ACWI, 0.02%.

6. “Passive” management of “active” management

It has been demonstrated that “the more changes we make to portfolios, the less returns we will obtain,” concludes Ismael García Puente.