Hello and welcome to Wealth Management Insights. I am Alper Daglioglu, head of Portfolio & Investment Manager Solutions for Morgan Stanley Wealth Management. And I am recording this on Tuesday, February 28th.
One of the most important jobs for us as investors is to strike an appropriate balance between offense and defense. Although markets displayed some risk-on behavior to begin this year, as investors were hoping the end of policy tightening was near, inflation is still far from the central bank’s target of 2%. The potential for “higher-for-longer” rates has meant a pickup in investor concerns and market volatility. And don’t forget, the Fed has already increased rates by around 5 percentage points in just about a year. It remains to be seen how the impact of tightening will flow through the economy and affect corporate earnings.
With all this, we believe that uncertainty for investors remains high. Given current market valuations that appear unforgiving, we continue to focus on investor caution and patience.
That, however, does not mean investors should run for the sidelines. In fact, selling based on fear would be one of the biggest mistakes an investor can make in a challenging market. Not only does this mean the investor locks in their losses, but it’s also unlikely that they know when to get back into the market—which could mean missed opportunities.
So instead of opting out of markets, investors can look for ways to potentially outperform, even as the backdrop remains challenging. I’d like to share three approaches.
- First, choose active managers. Volatility can provide a favorable setup for active managers, who can select investments that they find attractive and potentially capitalize on mispricings. What’s more, passive investments may introduce unwanted risk. For example, last year, the five biggest technology stocks in the S&P 500 made up 25% of the index at their peak. This kind of concentration is in line with levels from the tech bubble in 2000. We believe a portfolio should have both active and passive components, and now may be a time to increase your allocation to active. Seek out experienced investment teams with proven track records and processes that are well-defined, consistent and repeatable.
- Second, maximize potential after-tax returns. Many investors tend to focus only on pretax returns, but taxes can detract significantly from cumulative long-term returns. Using tax-smart strategies—such as tax-loss harvesting, direct indexing, and tax-efficient retirement accounts—may help improve realized returns, without adding a lot more portfolio risk.
- And finally, consider alternative investments. Investing in just stocks and bonds may not cut it anymore. A 60/40 portfolio, which is made up of 60% stocks and 40% bonds, lost about 16% last year. Given that these asset classes are likely to face continued headwinds, we recommend exposure to alternatives. They may serve not only to reduce volatility, but also potentially add income and increase overall return. Look to real assets, such as infrastructure and real estate, to potentially hedge against inflation. And, for investors who qualify, investments like private equity, private credit or hedge funds could make sense, as well.
If you are curious how you can implement these strategies in your own portfolio, please don’t hesitate to contact your Morgan Stanley Financial Advisor. Thank you all for listening.
Visit Wealth Management Portfolio Insights for more market commentary and insights from Alper and his team at Morgan Stanley. Find more audiocasts.
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