Gimme Shelter

This article is relevant to financial professionals who are considering offering model portfolios to their clients. If you are an individual investor interested in WisdomTree ETF Model Portfolios, please inquire with your financial professional. Not all financial professionals have access to these Model Portfolios.

Ooh, a storm is threatening
My very life today
If I don't get some shelter
Ooh yeah I'm gonna fade away

(From “Gimme Shelter” by The Rolling Stones, 1969. RIP, Charlie Watts)

We frequently caution investors and advisors to not get overly concerned about market movements during the summer months. Trading volume tends to be lighter and so market movements can be magnified.

But September and October frequently are months of dramatically increased volatility. The CBOE S&P 500 Volatility Index (aka, the “VIX”) is a widely used metric of broad market volatility. The red arrows in the VIX chart below correspond (from left to right) to September 1998, September 2002, October 2008, September 2011 and September 2015. (The large spike at the far right was, of course, in March 2020 when the COVID-19 lockdowns began.)

The current VIX level of around 16% is a little lower than the historical average of roughly 18%–20%. That is, investors are displaying a certain level of complacency about the market. Some of that, no doubt, is the summer doldrums, some of it is the fact that the Q2 earnings season was so strong, some of it is a general belief in a global economic recovery, and some of it is optimism about the Federal Reserve (Fed) maintaining its current accommodative stance (strengthened by Fed Chair Jerome Powell’s recent Jackson Hole comments) as well as the potential for additional fiscal stimulus.

But there are uncertainties out there: the evolution of the delta and other variants of the COVID-19 virus and its potential impact on schools and lockdowns, inflation potential, fragile geopolitical relationships between the U.S. and China, Russia and Iran and, of course, the events in Afghanistan (which, while fairly insignificant in terms of the global economy and markets, may potentially have an impact on consumer sentiment in the U.S.).

Bottom line—historical precedent and the current facts on the ground suggest that we may see a dramatic spike in market volatility over the next three to four months. Fortunately, we can help.

As part of our Outcome Focused Model Portfolio solution set, we offer three Multifactor Model Portfolios (U.S., Developed International and Emerging Markets). These risk-factor-diversified all-equity models are managed explicitly as complements to more broadly diversified portfolios, as a means of potentially dampening the overall portfolio volatility.

We wrote recently on the potential benefits of risk factor diversification, and this is exactly what our multifactor models are designed to do. Here is our risk factor “performance quilt” through June 30:

The point is not which factors currently are in the lead, but rather the swirling, constantly changing tapestry of leaders. Market conditions can and do change rapidly and are very difficult to predict. 

That is why all WisdomTree Model Portfolios are diversified at both the asset class and risk factor levels—we believe it helps to improve the consistency of performance through various economic and market regimes.

While the three WisdomTree multifactor models can be (and are) used as stand-alone portfolios—one of our largest relationships uses the U.S. model as its core equity holding—they were designed as complementary “sleeve portfolios” to allow advisors to increase risk factor diversification without necessarily disrupting the allocations of their existing portfolios.

Additional Potential Benefits

The multifactor models offer other potential benefits beside improved factor diversification. Specifically, improved asset style diversification, better quality, lower valuations and a higher dividend yield. 

Let’s look at a comparison of various metrics between the U.S. multifactor model, the S&P 500 Index, and the Russell 3000 Index:

You can see that the U.S. multifactor model currently is less concentrated in large-cap stocks, is trading at lower valuations (P/E and forward P/E), provides a better dividend yield, and offers an improved quality profile (ROA and ROE) in comparison to both the S&P 500 and Russell 3000 indexes.

Conclusion

As we reach the end of summer, the markets are relaxed and making Panglossian assumptions about the future (“All is for the best in this the best of all possible worlds”). But the fall historically has often slapped the market in the face with big doses of reality and volatility. Perhaps advisors and investors should consider a different approach—“plan for the worst but hope for the best.”

You can learn more about our multifactor models on our Model Adoption Center on the WisdomTree website.