Rishabh Saksena of Merrill Lynch Global Wealth Management looks at various product and investment opportunities based on the uncertainty and volatility in the market.

Date: Jun 2011

Tags: Asset allocation, ETFs, Volatility, Fixed income

• Volatility is a potential asset class for investors, given that it has demonstrated negative correlation to equities and research has shown that it tends to increase a portfolio’s risk-adjusted returns
• A challenge involved in adding volatility is determining whether to do so via exchange-traded notes, proprietary indexes or mutual funds
• While ETFs are a good way to access specific sectors or markets in an efficient way, investors need to consider the incremental risks, especially with commodity or leveraged ETFs, and in particular in relation to the performance

At an aggregate level, the uncertain investment environment impacts client appetite for an overall asset class, said Rishabh Saksena in an interview.

For example, in 2009, there were a lot of buying opportunities in fixed income, driven by volatility and changing risk appetite, he explained, adding that this shows how the overall sentiment of the market can play a role in market trends.

Volatility as a potential strategy

Volatility is a potential asset class for investors, said Saksena, given that it has demonstrated negative correlation to equities.

This was backed up by analysis done by the firm’s derivatives research team, which showed that adding volatility to a portfolio tends to increase risk-adjusted returns.

With this as a backdrop, it would make sense for clients to add a component of volatility as an asset class, said Saksena, which they can access via either funds or indices.

One of the challenges involved in adding volatility, however, is determining which way to do so, he added. One option is exchange-traded notes, another is proprietary indexes, and another is mutual funds.

ETFs and their application and suitability

According to Saksena, the firm has research coverage on exchange-traded funds (ETFs) when it is looking at specific types of the product where it feels it needs to be more cautious.

For example, when looking at leveraged ETFs or ETFs which are accessing the futures markets where negative roll returns are possible, the firm monitors those to ensure that clients understand the specifics of the ETF.

So while ETFs are a good way to access specific sectors or markets in an efficient way, he said investors need to consider the incremental risks, especially when thinking about commodity or leveraged ETFs, for example, and in particular in relation to the performance, which can vary from client expectations.

Tactical versus strategic asset allocation

Saksena said the firm’s research investment committee currently thinks that from an overall asset allocation perspective, it would tend to overweight equities versus fixed income.

So from that perspective there would be a tactical portion of the recommended asset allocation to clients which reflects the input of the research team – which is just a recommendation or guideline of strategic opportunities.