Investors are likely to remember 2018 as a challenging year. Stocks gyrated and rising interest rates put pressure on the bond markets. We asked John P. Calamos, Sr., to explain what’s been going on in the markets and to discuss how the Calamos Wealth Management team is positioning clients for the road ahead. John is the Founder, Chairman and Global Chief Investment Officer of Calamos Investments and has been navigating volatile markets for nearly 50 years.
Why have financial markets been so volatile in 2018?
Markets hate uncertainty. Volatility has stemmed from political unknowns, such as trade policy and elections. Geopolitical uncertainties related to the euro zone, Brexit, the Middle East and Russia have also weighed on market sentiment. In addition, there has been a lot of market apprehension about the Federal Reserve and how higher short-term U.S. interest rates will influence the global economy and corporate profitability. These concerns are likely to distract markets next year, too. So, investors should be prepared for continued volatility.
With all of these uncertainties, should investors be worried that a U.S. recession is right around the corner?
The markets and the economy are two different things. While I expect market volatility to be a defining feature of 2019, I believe the U.S. economy can continue to grow. Although a slowing global economy and geopolitical issues pose potential risks, I don’t see recession in 2019 as the probable outcome. Economic fundamentals are still intact, such as positive GDP growth and subdued inflation.
With volatility likely to continue, what are the biggest risks you see for investors in 2019?
The biggest risk is having a short-term mindset. Investors need to recognize that short-term swings in the market are normal. Historically, it’s been quite common for the stock market to pause or retreat before moving upward again. Investors who continually hop in and out of the markets to avoid short-term downturns are likely to miss rebounds. In contrast, investors who put time on their side—and stay invested—are better positioned for the long-term.
I’m also concerned about the potential risks of passively managed investment strategies, like index funds. Passive strategies can’t respond to evolving market conditions the way actively managed approaches like ours can. Our investment teams are continually seeking out ways to enhance the balance of risk and return in their portfolios. Also, our clients’ portfolios benefit from ongoing oversight by the Calamos Wealth Management Investment Committee and dedicated Wealth Advisors. This multi-pronged approach gives our clients advantages that passive strategies can’t replicate.
What are some key themes shaping your asset allocation approach in 2019?
First, every client has different circumstances, so there’s no single asset allocation that is right for everyone. But when it comes to asset allocation, risk management is always important. I see many opportunities for active managers in 2019, but as I noted, volatility is likely to continue. In this environment, I believe strategies that can play both defense and offense will have a real advantage in 2019.
On an ongoing basis, our Investment Committee and Wealth Advisors work together to assess market conditions and their impact on client portfolios. Given the dynamics in the market, capital preservation remains a high priority.
For many clients, we believe it makes sense to increase exposure to defensive equity strategies. Defensive equity strategies are designed to provide participation in market upside with a focus on cushioning losses on the downside. On the fixed income side, our approach is to be more defensive in the face of rising interest rates.
What are some examples of strategies that can be used to enhance defensive positioning in an equity allocation?
In many cases, we recommend using alternative strategies to provide defensive equity participation. This could include a hedged equity allocation that seeks to achieve the total return of equity markets, but with lower volatility.
In other cases, we may include a long/short allocation to pursue strong risk-adjusted and absolute returns across the global equity universe. Our long/short approach has many tools at its disposal, including the flexibility to short stocks. Shorting stocks offers the potential to profit when stocks are going down, as well as when they are going up.
In addition to alternatives, are there other ways to pursue defensive equity participation?
Yes, when we develop a wealth strategy for a client, we have many tools in our toolkit for defensive equity exposure. In fact, I believe our breadth of risk-managed strategies and our focus on capital preservation are important advantages we bring to clients.
Since the 1970s, Calamos has used convertible securities as a strategic allocation for risk-managed exposure to the stock market. Convertible securities combine characteristics of stocks and bonds, and they have been a compelling choice for defensive equity participation over many market cycles. With active management, convertible securities can be a welcome addition for clients who are apprehensive about being in the markets but don’t want to be on the sidelines either.
In strategic allocations, we can use convertibles in many ways. For example, we may pair them with stocks or use them in a dedicated convertible strategy. The strategies we choose depend on each client. In some cases, we may invest primarily in U.S. convertibles, but for many clients, we are also using convertibles for risk-managed participation in global opportunities.
Investors often look to bonds to mitigate the impact of stock market volatility, but rising rates have historically created headwinds for some types of fixed income investments. In this environment, are there ways to enhance fixed income allocations?
Investors historically have turned to fixed income investments to provide income and dampen volatility, and fixed income is an important strategic component for many asset allocations. But in a rising rate environment, investors may want to include strategies that are less exposed to interest rate risk.
The good news is that there are ways to increase the defensive positioning of a fixed income portfolio in the face of rising interest rates. For example, we can use alternatives. For a number of clients, we include a market neutral income allocation as a fixed income alternative. It’s one of Calamos’ pioneering capabilities, extending back nearly 30 years. To generate income, we use investment strategies that haven’t demonstrated high correlation to interest rates. In our market neutral income approach, we also seek consistent returns with lower volatility.
Earlier, I discussed using convertibles within a strategic (long-term) allocation for defensive equity participation. We also use convertibles tactically to enhance fixed income allocations during rising rate environments. Convertibles offer the opportunity for income through their coupons, but with less sensitivity to interest rates than traditional investment grade bonds.
Finally, rising interest rates tend to have the greatest impact on longer-term bonds. So, in a rising rate environment, shorter-term bond allocations can be an appealing choice for income and lowering exposure to stock market volatility.
Any closing thoughts?
I’ve been working with clients for more than 40 years, and I know how difficult volatile markets can be for investors. The headlines can be sensational and even scary. What’s important to remember is that Calamos Wealth Management has many tested investment approaches for climates like these. And, our team is always available to discuss questions or concerns with our clients.