Volatility Concerns: The Disparate Views of Advisors & Clients

According to a recent survey conducted by Eaton Vance, and as reported by Financial Advisor IQ, advisors and clients have disparate views on volatility, specifically, why it matters.

“The survey also found a gap between how advisors and clients approach volatility. Among advisors, 54% say they manage and harness it, 17% want to use volatility to their advantage, and 18% just want to manage it enough to avoid losses. By contrast, 48% of clients just want to avoid losses, while only 32% want to manage volatility as well as harness it and 14% see it as an opportunity.”

While we’re not exactly certain what is meant by “harnessing” volatility, as that sounds an awful lot like one of the other potential responses – using volatility to one’s advantage – it’s clear that preventing losses is the reason that clients care about volatility, while advisors judge that to be of lesser concern. While we have no doubt that the survey’s results do reflect the views of the larger advisor community, our advisor-client base seems to think differently about the subject. The conversations we’ve been having with advisors increasingly have centered around managing volatility specifically to avoid losses. This could be especially important at a time when, according to Goldman Sachs, stocks are reaching “peak optimism“.

In fact, using As Reported earnings for the S&P 500 as of year-end (with about 87% of companies reporting), in order for the P/E on the S&P 500 to revert to its long term average of 17x (post 1936), one of two things would have to happen, all else equal:

    • The S&P could decline by about 30%, or
    • Earnings could grow by about 43%

Given the size of the moves required to reach average valuations, “peak optimism” would seem safe from being criticized as hyperbole.

So back to the question of volatility, and whether or not it should be managed or not, and if so, for what reason. Before investors make the decision to reduce volatility in their portfolios, they first have to believe that volatility is something to be avoided, that it matters. We’ve heard market pundits say that volatility isn’t risk, but rather that risk is the permanent loss of capital. Such statements rightly question that risk can be fully explained by a number, but incorrectly dismiss the fact that the higher the volatility of an asset, the greater the uncertainty around the value of the asset when you need to sell it. Which is a reminder that protection from adverse market events needs to be in place prior to volatility spikes in order to be effective. That is, if you care about volatility…clients certainly do.