Investing to protect on the downside

Glenn Freeman | 30/06/2017

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Roy Maslen: So, when we think about market volatility, it's ultimately when you see the market having rises and falls day-to-day. And why does that matter? Well, it's because it's often associated with fear or uncertainty in markets and it can lead to market falls. In fact, in Australia, in two out of three years we do see falls of 10% or greater in Australian equities.

Now, many investors want to invest in equities because they like the return potential for capital growth and income and franking credits. And when they get those falls in markets, a number of investors can find that a pretty painful experience.

Yes, I think that is a risk, but let me put that into a broader context, because if you build a portfolio of strong, stable stocks that are diversified in nature, then our research has indicated that they can fall less than the market when it's down. Conversely, when the market rises, they may not capture all of that upside.

But if you look here on Australian equities over the past, since 1990, if you've invested in a strategy that could fall half as much as the benchmark when it was down, but when the market is up, even it only captures 80% of that upside, then in the long run you'd have outperformed the benchmark by more than 3%. So, if you can have that downside protection, you can get good long-term returns albeit in periods of strong market rallies you may lag a little. But the benefit is, you help protect on the downside.

This report appeared on 2017 Morningstar Australasia Pty Limited

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