Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 238

Managing the threat of rising volatility risk

Over the last year, volatility has remained stubbornly subdued, hitting new lows on a regular basis. This trend has been seen across many markets and asset classes, including the often unpredictable emerging markets. US equities led the way, shrugging off public policy uncertainty, the Fed’s rate hikes, and natural disasters.

How low can it go?

Source: Bloomberg. 1/12/17.

Looking ahead, several key risk factors could come into play. There is considerable uncertainty around key geopolitical relationships and the pace of monetary policy tightening. As global growth takes hold, central banks are beginning to rein in their unprecedented quantitative easing programs. Many countries also have a long way to go in implementing structural reforms. And bond and equity prices looking increasingly expensive, particularly in developed markets.

Can volatility remain this low indefinitely? Will interest rate normalisation put a spanner in the works? And, if volatility does pick up, how can investors not only manage the associated risks, but also take advantage of the opportunities presented?

Ready to revert?

Traditionally, volatility has been mean-reverting, returning to average levels over time. Analysis from Legg Mason’s global equity affiliate, Martin Currie, suggests volatility is now at 50+ year lows. Large declines in correlations between stocks, as well as a drop in the individual volatility of stocks themselves, are behind this phenomenon.

If tighter labor markets and higher inflation start to emerge due to sustained global growth, it could initially cause higher volatility in fixed income markets, which may then feed into equity markets. Equity volatility tends to lag changes in the yield curve by around 30 months, according to Legg Mason global equity affiliate ClearBridge Investments. In their view, while quantitative easing acted as a pacifier of volatility, quantitative tightening may act as an accelerant.

Fixed income as a leading indicator of volatility

Source: Bloomberg, 1/12/17. Indexes are unmanaged and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

A prolonged period of low volatility can also act to increase the scale of volatility once it returns. Many risk models are built using measures of short-term historical volatility and may now be “increasingly underestimating the true level of risk in portfolios”, according to Martin Currie. A pick up in volatility could, therefore, lead to a more rapid market response as risk models adjust from their low base.

Furthermore, investors are expecting markets to continue to perform well as the economic environment remains benign. Hence, the risk of disappointment is skewed to the downside. A deviation from expectations could cause an outsized movement in asset prices.

What investors can do

The implications of higher volatility for portfolios are not always negative. What can investors do?

  • Buy low-volatility stocks: One approach to the challenge of an uptick in equity volatility is to explicitly seek out stocks with properties that can minimise volatility, both individually and as components of an overall portfolio. A good example is companies with strong dividends that are sustained by the financial and business fundamentals of their underlying businesses. The overall financial characteristics of strong dividend payers can reduce a stock’s vulnerability to rapid market changes.

  • Move fixed income away from benchmarks: A more flexible, unconstrained approach to fixed income may help manage risk, by allowing greater scope to access the full global bond landscape as well as individual security selection. By dynamically shifting allocations in line with market conditions, unconstrained managers can identify the most compelling, potentially undervalued bond markets and currencies — as well as regions, countries, or sectors that offer a better yield or where duration risk should be rewarded — while avoiding or even shorting areas of concern.

  • Consider active management: As volatility feeds into equity markets, active management may also help to manage risk. For example, strategies designed to invest in stocks with a historical tendency to resist periods of volatility can help protect portfolios from the full scale of any downturns. Lower correlations among stocks and a higher dispersion of returns across the market also creates more winners and losers. As Martin Currie notes:

We are conscious of increasing dispersion in returns within the asset class, and the consequent need for investors to be selective. This is best achieved through taking an active, fundamentally driven approach to investment, and a focused, stock-picking strategy is very well placed in this regard.”

Additional information, particularly around (ESG) environmental, social and governance issues, can increase a manager’s conviction in the sustainability of a company’s returns, even during periods of market volatility. An active manager with an ESG framework can also be an engaged investor, working with companies to create sustainable long-term returns.

 

Andy Sowerby is Managing Director at Legg Mason Australia, a sponsor of Cuffelinks. This article is general information and does not consider the circumstances of any investor. The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.

 

  •   1 February 2018
  • 1
  •      
  •   

RELATED ARTICLES

Five reasons to hold your investment nerve

VIX, XIV and all that jazz

Howard Marks on risk and how To handle It today

banner

Most viewed in recent weeks

How cutting the CGT discount could help rebalance housing market

A more rational taxation system that supports home ownership but discourages asset speculation could provide greater financial support to first home buyers.

3 ways to fix Australia’s affordability crisis

Our cost-of-living pressures go beyond the RBA: surging house prices, excessive migration, and expanding government programs, including the NDIS, are fuelling inflation, demanding bold, structural solutions.

Is there a better way to reform the CGT discount?

The capital gains tax discount is under review, but debate should go beyond its size. Its original purpose, design flaws and distortions suggest Australia could adopt a better, more targeted approach.

Want your loved ones to inherit your super? You can’t afford to skip this one step

One in five Australians die before retirement and most have not set up their super properly so their loved ones can benefit from all their hard work and savings. 

Welcome to Firstlinks Edition 648 with weekend update

This is my last edition as Editor of Firstlinks. I’m moving onto a new role though the newsletter will remain in good hands until my permanent replacement is found.

  • 5 February 2026

Super is catching up, but ageing is a triple-threat

An ageing Australia is shifting the superannuation system’s focus from accumulation to the lifecycle of retirement. While these pressures have been anticipated for decades, they are now converging at scale and driving widespread industry change.

Latest Updates

Economy

Has Australia wasted the last 30 years?

The 20 years after Peter Costello left Treasury have been deemed wasted...by Peter Costello. The missed opportunities for Australia began long before.  

Retirement

Navigating the next stage of life in retirement

Retirement planning is more than just saving enough money. Long-term care needs, housing choices, and social networks are just as critical for a happy and enjoyable life.

Strategy

Showcasing your value in the age of AI shortcuts

Knowledge is becoming commoditized in the age of artificial intelligence but experience, taste, and judgement are still at a premium.

Planning

Financial advice as the pathway to economic security

Financial advice can lead to improved financial literacy, a healthier super balance and a higher standard of living in retirement. Is now the time to give yourself the gift of financial advice?

Economy

The overlooked driver of energy inflation

The impact of energy policy on inflation in Australia is often overlooked. Transitioning to renewable energy can lead to inflated costs that affect the entire economy and productivity growth.

Economy

A 2026 rotation story: Europe’s undervalued small caps

In 2026, Europe is poised for a 'Goldilocks' scenario with cooling inflation and lower rates, driven by fiscal stimulus. Small caps offer an attractive entry point before capital rotation.

Investment strategies

What we do when things go up (a lot)

Recent price spikes, particularly gold's surge, trigger behavioral responses like availability bias, storytelling, extrapolation, and FOMO, which create self-reinforcing feedback loops influencing investor sentiment and market trends.

Sponsors

Alliances

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.