The firm found two out of three institutional investors (67%) believe the level of volatility in markets will rise this year, with 6% predicting a dramatic increase.

Carne Group commissioned Pureprofile to interview 201 investors working for pension funds, family offices, wealth managers, insurance asset managers and consultants across the UK and continental Europe. Those taking part had a total of $1.7trn under management and were spoken to in December 2023 or January 2024.

See also: It’s time for multi-asset managers to ditch bond proxies

The researchers also found that close to nine in 10 investors (88%) said they believe their organisation’s appetite for risk will be higher this year, with 11% saying it will be much higher.

Among pension funds alone, 92% expect risk appetite to be higher, with 6% expecting it to be much higher, while for family offices the corresponding figures are 83% and 20% respectively.

Around 86% of insurance asset managers expect an increased risk appetite with 6% said it will be much higher. For wealth managers the figures were 85% and 14% respectively and for consultants they were 96% and 13%.

In terms of which alternative asset classes are most appealing, around 65% of those interviewed chose hedge funds as among the top three private asset classes for growth in inflows, while 57% selected venture capital and 56% said private equity.

The full findings:

John Donohoe, CEO at Carne Group, said: “Sustained stockmarket volatility and investors seeking higher returns has driven increased interest in alternative asset classes which generally show lower levels of correlation to short term price movements, which is important not only for diversification but also for regulatory purposes.

See also: Chancery Lane CEO: Modern portfolio theory doesn’t work for income investors

“The growing focus on alternatives is not a short-term move either, with institutional investors predicting strong but selective growth in inflows to alternatives over the next five years. One area we are seeing a particular increase in inflows is private debt, and our research suggests this is likely to continue.”

We have often heard the saying “Nothing ventured, nothing gained”. This pithy saying captures the essence of investing – without risk, there is no reward. However, risk implies different things to different people.

While some perceive risk to be a permanent loss of capital, others consider the variability of returns as a measure of risk. Over time, we have developed metrics which help us quantify risk, so that it is understandable and communicable. In trying to do so, we have relied on mathematical models, borrowing ideas from different fields to develop and enrich the vocabulary of risk.

However, a fallout of this has been ever increasing complexity, resulting in a lack of clarity in the true understanding of what we are trying to communicate.

Statistically speaking, the variance of returns of an asset class, as measured by the standard deviation, has become synonymous with risk since being introduced by Harry Markowitz in his seminal work on Portfolio Selection in 1952.

Incidentally, the paper, which won him the Nobel Prize for Economics in 1990, has no mention of the word “risk” in describing his investment strategy. He simply identifies that variance of returns is an “undesirable thing” that investors try to minimise.

Fast forward to the present day, the concept is mathematically linked to the standard deviation – the greater the variance or the standard deviation around the average, the less the average return will signify about what the outcome is likely to be.

Ground-breaking as the theory was, matters of practicality played a very important role in the implementation of the measure. Markowitz assumed that that practitioners would have no difficulty estimating the inputs to the model—expected returns, variances, and the covariances among all the individual holdings or asset classes.

However, to estimate these inputs, practitioners need to rely heavily on historical data. Consider historical data before the great financial crisis of 2008 – estimating inputs like volatility depends on decisions as to whether we include or exclude data during the event. The outcome of this decision results in a significant variation in the estimates.

Another issue stems from the idea that the returns on each asset, or for that matter a security, can be described with only two numbers: expected return and variance. Dependence on just those two numbers is appropriate if, and only if, security returns are normally distributed like the Bell curve, as described by Gauss.

Under such a distribution, no outliers are permitted, and the array of results on either side of the mean must be symmetrically distributed. When the data are not normally distributed, the variance may fail to reflect the full scope of the uncertainties in the portfolio. We come across this issue often.

Consider a simple example as in Figure 1 – it shows the distribution of monthly observed returns of the Dow Jones Industrial Average against the NASDAQ Composite Index. As all practitioners are aware, the Dow is composed of 30 of the most analysed and followed stocks, while the NASDAQ contains stocks of high growth, smaller companies. A quick inspection of the two distributions informs us that none of the distributions have the typical symmetric characteristics of the bell curve.

Figure 1: Distribution of Monthly Returns of Dow Jones Industrial Average Index and Nasdaq Composite Index

Source: Dynamic Planner

However, the Dow is a closer approximation than the Nasdaq index, which has much larger left tails, signifying a greater probability of large negative performance than the Dow. Thus, using a measure which relies on a symmetric distribution does not do justice to the risks posed by holding such an asset. This issue gets exacerbated as we delve into thinly traded stocks – as the example in Figure 2, which are the distributions of Google and DMC Global, a well-known Large Cap and Small Cap stock.

Figure 2: Distributions of monthly returns of Google and DMC Global

Source: Dynamic Planner

As can be seen, DMC Global has a bigger variation of returns along with a greater probability of large negative returns in comparison to the returns of Google. The second example provides an insight into the nature of instruments and their range of the prices.

Nevertheless, volatility, or variance, has an intuitive appeal as a proxy for risk. Statistical analysis confirms what intuition suggests: most of the time, an increase in volatility is associated with a decline in the price of the asset. Moreover, intuition and experience tell us that uncertainty should be associated with something whose value jumps around a lot over a wide range.

Yet there is no strong agreement on what causes volatility to fluctuate or even on what causes it in the first place. The only thing certain about volatility is that it sets in when the unexpected happens. But that is of no help, because, by definition, nobody knows how to predict the unexpected. On the other hand, not everyone worries about volatility. Even though risk means that more things can happen than will happen—a definition that captures the idea of volatility—that statement specifies no time dimension.

Once we introduce the element of time, the linkage between risk and volatility begins to diminish. Time changes risk in many ways, not just in its relation to volatility, which leads us on to various other measures of risk.

While volatility remains the preferred measure of risk, delving into its mechanics and nuances can help us navigate uncertainty with a degree of comfort.

This article was written for International Adviser by Abhi Chatterjee, chief investment strategist at Dynamic Planner.

The workflow model is currently free to all existing Engage users.

It will allow advisers to see the impact that drawing a regular income from a pension can have on a client’s accumulated wealth.

Additionally, the tool factors in the “probability of volatile markets”, Defaqto said, as well as considering “the potential impact of sequencing risk.”

The firm added that not many software providers can offer sequence risk calculators among their tools, especially when it comes to drawdown.

Decumulation vs accumulation

Pan Andreas, head of insight and consulting for funds and DFM at Defaqto, said: “Our income drawdown workflow has been a long time in the making. This workflow provides a step-change in the right direction for advisers with clients in the decumulation phase.

“This year, in particular, has been challenging. But sequence risk always plays a role and advisers need tools that work seamlessly within their advice processes.

“The majority of investment workflows were originally designed to cater for the accumulation phase. As such, they mostly ignore the effect of sequencing risk when clients move to decumulation. They do little to highlight the appetite and capacity to bear income fluctuations when planning clients’ income in retirement.

“With our income drawdown workflow, advisers no longer have to create a fragmented report from several tools. Using an actuarial model, we’ve created an invaluable workflow that produces provider agnostic research specifically developed for decumulation.”

In its latest Money Relationship Monitor report, SJP Asia discovered that as many as 60% of retail clients would divest equities within a week of a market downturn and 32% said they would do so within 24 hours.

While this would have a great impact on their financial lives, 41% of respondents revealed they have no financial planning whatsoever.

SJP Asia warned that the failure to plan is driving Singaporeans to make decisions about their financial lives based on emotions rather than facts, which is also making it harder for retail clients to meet their wealth creation goals.

Beyond savings

Most people (57%) in Singapore said they aspire to commit more than 20% of their annual income to savings, but only 44% said they managed to achieve this.

Two-in-five are dissatisfied with the current savings levels or are unsure if they are enough.

But for those who actually have a financial plan in place, 14% have not taken into consideration the cost of inflation.

The top reasons that are keeping Singaporeans from saving more are high living costs (38%), lack of discipline when it comes to spending money (37%), and a lack of balance between costs and income (28%).

Gary Harvey, chief executive at SJP Singapore, said: “Sound financial planning goes beyond just saving to provide a clear pathway for wealth creation over time.

“Amid economic uncertainty, a plan is critical as investors are more likely to act on emotion rather than fact. This behaviour does not always translate to better long-term investment outcomes.

“Our own modelling shows that investors who divested equities within twenty four hours of markets starting to fall on 19 February this year, and did not re-enter, would have lost around 18% of their investment value; by comparison, those who stayed invested would have most likely gained.”

Wealth and happiness

SJP Asia is urging Singaporeans to rethink their approach to financial planning especially because 83% admitted that being wealthier would make them happier and 72% referred to a lack of money as a source of stress within their family.

Additionally, nearly nine in 10 (89%) have prioritised generating alternative sources of income within the next 12 to 24 months.

A recent study on investor behaviour between Hong Kongers and Singaporeans revealed that the latter group is more concerned with wealth creation, whereas people in Hong Kong are more likely to prioritise preservation of wealth

Harvey added: “The perceived trade-offs between wealth and happiness is a classic dilemma. Pursuing financial freedom through salaried income alone can result in cyclical behaviour and many don’t recognise the price they pay by not taking greater control of their finances.

“With proper planning and advice, Singaporeans can invest prudently, diversify income streams, and ensure they are more robustly prepared for the future. Accumulating wealth does not need to come at the expense of a balanced lifestyle, it requires a plan.”

The company said that the sell-off induced by the pandemic and lockdown has tested this type of investment vehicles; and the fact that they are designed to “absorb some level of losses” before the end investor starts losing money could hit retirees hard. 

Matthew Yeates, senior investment manager at 7IM, said that considering markets shed as much as a third of their value during the covid peak, many structured products will now be “underwater”. 

“Structured products specifically would have been among the most volatile products to own through the period, and given the scale of the falls in markets we have seen, the drawdown across parts of the structured products market has been brutal,” he said. 

‘Plain dangerous’ 

This could become a major problem for those who turned to these investments to generate income after they stop working. 

“The key difference for investing in retirement is that investors only get one chance to get it right,” Yeates added. “Using structured products or relying on natural income doesn’t cut it. 

“Investment solutions for retirement should be built on solid foundations, and not expose investors to the worst of market falls when there is a correction. Unfortunately, defined income structured products usually do exactly that, which is just plain dangerous. 

“This could be an accident waiting to happen for lots of retirees when they come to review their investments post the crisis, and find that the capital they thought they had is now much lower.” 

‘No evidence’ 

But Clive Moore, managing director at structured products provider Idad, told International Adviser that there is no basis to these claims.  

“This is complete hogwash and backed up with no evidence at all. Structured products come in all shapes and sizes but should be designed to match investor objectives in the most efficient and accurate way they can.  

“For example, an investor seeking income can access a much higher level of income than available from traditional sources, together with more capital security over the life of the investment term.  

“If investors can’t hold an investment for the term it’s designed for, they shouldn’t be buying structured products. Unlike many other asset classes – property funds, Ucits funds invested in illiquid assets – structured products offer intra-day liquidity, provided by the largest financial institutions in the world.  

“The prices during the investment term can be very volatile, but the products are designed to be held for their full term, so this should be of no concern to investors or advisers except in extreme circumstances, where liquidity is always available – unlike other asset classes.  

“The performance of structured products speaks for itself and there are millions of satisfied investors who can testify to this. We and other organisations regularly publish performance statistics demonstrating quite how much outperformance structured products have delivered.  

“There have been a few instances of structured products being used wrongly in the past, but I don’t think there’ll be many in the fund industry throwing stones in their glass house at the moment,” Moore added. 

A different approach 

But according to Yeates, retirees should focus on flexibility and diversification. 

“Investors looking for a portfolio that maximises their chance of meeting their retirement spending needs should focus on the total return of portfolios, incorporating both capital returns and income. 

“We believe in a long-term, total return approach to retirement income. To allow us to take a long-term approach, we split investments into different pots that provide for short-term income needs, longer-term needs and a buffer to provide income when periods of volatility arise. 

“We have rules in place to follow for rebalancing portfolios when markets are up or down. This approach allows us the flexibility to look across all types of investments, not just those with high levels of ‘natural’ income.  

“In turn, it gives retirees the flexibility to work out how to spend their total return in retirement, without worrying that they’re getting a little less this year from dividends.”