Risk speedometer: Fast but steadying

March 17, 2017

 

Key highlights

  • Our risk speedometers show that the trend of investors' willingness to take on risk continued as stock prices continued to rise.
  • Investors' strong preference for riskier assets further amplifies their exposure if there is a downturn in the markets. This should be a concern, given the guarded market outlook.
  • Amid a long bull market, this may be a good opportunity to check up on your clients' portfolios to make sure they aren't overexposed in the event of a market correction. Rebalancing can help reduce downside risk.
 

Global equity markets rose for the fourth consecutive month in February, with the FTSE Global All Cap Index returning 2.8%. Once again, investor cash flows followed suit and continued to flood into riskier asset classes, including U.S., international, and sector equities. In February these funds and ETFs gathered nearly $43 billion in net cash flow, bringing their three-month net cash flow to $109 billion. This is the largest three-month net investment since December 2013 and the eighth-largest in history.

risk speedometer March

As far as Vanguard's risk speedometers are concerned, the large net inflows to equity funds and ETFs, as well as other risky asset classes, were partially offset by the $25.7 billion net inflows into U.S. taxable bond funds and ETFs, which were the largest since October 2009. This caused our one-month risk speedometer to back off a little from January, but it remains high and well above its five-year average. For three consecutive months now, investors have shown a preference for higher-risk assets, which is clearly affecting longer-term trends. The three-month risk speedometer had a huge acceleration in February, after posting in January its first positive reading relative to its five-year average since June 2015. While the 12-month risk speedometer remains well below its five-year average, it's slowly trending upward from prior observations. Its low level indicates just how low the risk-taking was for most of 2016.

Checking your clients' speed

In the end, advisors earn their value by ensuring their clients have the best chance for meeting their financial goals. The combination of a prolonged equity bull market, investors' rising willingness to take on risk, and forecasts for muted market returns1 makes this a good opportunity to check up on your clients' portfolios. Given that the portfolios were likely constructed with the clients' risk tolerance in mind, it is critical to make sure they are still within their acceptable range of risk tolerance, and rebalance if needed. Doing so helps your clients stick to their investment plans and endure market downturns, positioning them to better meet their long-term financial goals.

assets

Not visible in our speedometers but comforting in February's cash-flow numbers is that many advisors and investors appear to have an eye on steadying portfolios as the markets race ahead. That intermediate-term bond funds are among the biggest winners on a dollar basis can be taken as a sign that caution is appropriately setting in. That said, the current mix of assets, as shown in the chart above, suggests there is still plenty of opportunity.

Remember, rebalancing is not about maximizing returns, reversion to the mean, or market forecasts—it is about maintaining the risk-and-return characteristics of the portfolios that investors selected based on their unique time horizon, risk tolerance, and financial goals. In contrast to market predictions, rebalancing is within our control.

Highest net inflows and outflows

Top winners
1-month inflows ($B) 3-month inflows ($B) 12-month inflows ($B)
Inter.-term bond$12.2 Large blend$43.3 Inter.-term bond$123.0
Large blend$10.5 Foreign large blend$26.7 Large blend$89.5
Foreign large blend$8.0 Inter.-term bond$20.5 Foreign large blend$55.2
 
1-month inflows (% of AUM) 3-month inflows (% of AUM) 12-month inflows (% of AUM)
Trading-levgd. cmdty.9.1% Bank loan15.3% Volatility110.9%
Latin American stock8.1% Trading-levgd. debt14.7% Cmdty. ind. metals106.4%
Eq. precious metals6.1% Financial13.1% Industrials62.3%

Source: Vanguard calculations, using data provided by Morningstar, Inc.

Top losers
1-month inflows ($B) 3-month inflows ($B) 12-month inflows ($B)
World alloc.–$1.6 Money market–$33.4 Large growth–$107.6
High yield–$0.6 Large growth–$21.5 Money market–$96.9
Int. government–$0.6 World alloc.–$6.2 World alloc.–$30.9
 
1-month inflows (% of AUM) 3-month inflows (% of AUM) 12-month inflows (% of AUM)
Communications–3.3% Cmdty. misc.–31.8% Trading-levgd. debt–53.0%
Option writing–2.8% Target-date funds–21.0% Cmdty. misc.–48.6%
Single currency–2.7% Cmdty. energy–17.6% Cmdty. energy–37.1%

Source: Vanguard calculations, using data provided by Morningstar, Inc.

More about Vanguard's risk speedometers

We've long tracked industry cash flows to develop insights into what investors, collectively, are doing with a substantial portion of investable assets.2  Our risk speedometers—our unique lens on investor behavior that we introduced in January—and related cash-flow research also highlight trends that may not be apparent in raw cash-flow data. The result is a nuanced picture of how investors are responding to market developments. These nuances sometimes reveal that the reality of investor behavior is more complex than conventional wisdom suggests.

Fran Kinniry, Don Bennyhoff, and Yan Zilbering, members of Vanguard Investment Strategy Group, developed the risk speedometers to gauge the level of risk investors are taking in a given period. It's simply the difference between net cash flows into higher-risk asset classes, such as stocks, and lower-risk asset classes, such as fixed income. The speedometers compare investors' current risk-taking with longer-term averages.

1 For an in-depth look at Vanguard's economic and investment outlook, view our 2017 economic and market outlook: Stabilization, not stagnation.

2 According to data from Morningstar, Inc., assets under management for U.S. open-end mutual funds, money market funds, and ETFs totaled $17.7 trillion as of December 31, 2016.

Notes:

  • All investing is subject to risk, including possible loss of principal.
  • Diversification does not ensure a profit or protect against a loss.
  • Investments in bond funds are subject to interest rate, credit, and inflation risk.
  • Foreign investing involves additional risks, including currency fluctuations and political uncertainty.
 

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