3 Reasons to De-Risk Your Portfolio

Recently, equity markets have approached, and in some cases surpassed, record highs. But from politics to policy, there are nonetheless many moving parts that can cause markets to fluctuate—sometimes swinging dramatically up and down—which can create a challenging environment for investors. With so much happening in the world today, we could be in store for more volatility. Here are three reasons to consider de-risking your portfolio.

1. A Catch to Interest Rate Cuts

For the first time in over four years, the Bank of Canada (BoC) cut its policy interest rate, becoming the first G7 nation to do so—beating the European Central Bank (ECB) by one day. With the odds heavily in favour of a decrease (at about an 80%) prior to the event, the market was largely expecting the outcome. BoC Governor Tiff Macklem acknowledged the inflation rate has moved closer to the 2% target, suggesting the bank’s monetary policy no longer needs to be as restrictive, which is good news for investors. But as it often happens, good news can come at a price. Recently, gross domestic product (GDP) growth has been a little weak, the job market is sending mixed signals, and Canadian productivity has been relatively stagnant compared to the U.S. While rate cuts are great for equities, variable mortgages, and corporations seeking to borrow, there is another—implicit—side to the story, which is the economic backdrop is not as strong as it once was.

As a result, it’s too early to announce a big momentum story off the back of interest rate cuts. But as more start rolling in, it can unlock value in sectors that were negatively impacted by the higher for longer interest rates, such as Utilities, Real Estate, and Consumer Staples. A low volatility strategy can help you manage risk, while also benefiting from falling interest rates. In terms of your Canadian allocation, the BMO Low Volatility Canadian Equity ETF Fund provides exposure to equities and is overweight defensive sectors (like those mentioned above).

2. The U.S. Federal Reserve is in a Holding Pattern

The story is quite different south of the border, where interest rate cuts are proving much more difficult to come by. At the start of the year, markets were pricing in six cuts from the U.S. Federal Reserve (Fed) in 2024. At the time of writing, economists are predicting one or two, which is a long way from where it began. In the U.S., the economy and consumers remain more resilient and inflation stickier. Given this environment, there is added risk. Look at the S&P 500, for example. The index gained more than 300 points in a recent broad-based rally¹ predicated on lower interest rates—which we may or may not see.

To gauge the level of risk, we often look to the VIX, a popular measure of equity volatility. The index, however, has been sitting around 12 or 13,² which is relatively subdued and below the historical average.³ It’s important to note: the VIX can change in a hurry—as was the case last October when the index spiked for a stint, causing downside in equity markets—and this may be the calm before the storm. Looking ahead to October and November, we are seeing a bump in volatility associated with the upcoming U.S. presidential election. So, there may be risks on the horizon.

For your U.S. allocation, you have to think a bit differently than Canada. The big driver has been Technology, as many of us know. But we can’t lose sight of how much Information Technology (IT) is in the S&P 500 index—there’s a weight of about 30%. And that’s in addition to other companies that we commonly consider to be tech (like Google, Netflix, and Amazon), but are now categorized as Communications Services or Consumer Discretionary instead. By piecing these together, real tech companies make up almost half the index. Stocks are nearing (or surpassing) all-time highs and valuations are getting stretched. This is where diversification can be a tool to help your portfolio benefit under different economic conditions. For instance, the BMO Low Volatility U.S. Equity ETF Fund can provide a hedge against growth. If Technology continues to deliver, having that exposure is great. At the same time, if there is a correction in volatility, having defensive tools can help. We often say that low volatility is about “winning by not losing”—which means rather than aiming for the highest possible returns, you can reach for steady growth and set yourself up for future success by preserving capital during negative equity markets.

3. Escalating Geopolitical Tensions

Lastly, we must consider the geopolitical environment we are in. The Middle East is a powder keg right now, the conflict in Russa and Ukraine seems relentless, and there is a lot of sabre-rattling by China. With the ongoing unrest, ensuring you have defensive tools in your portfolio can help you be proactive rather than reactive.

A low volatility strategy, like the BMO Global Low Volatility ETF Fund, can help manage risks from geopolitical events on the equity side of your portfolio and provide a more defensive posture. There are also many ways to build around the edges of your portfolio to make it more resilient. We recently launched the BMO Gold Bullion ETF (Ticker: ZGLD), which provides cost effective exposure to gold—and you don’t necessarily need a lot of it to make a difference. When markets have been at their worst, gold is often the thing that is shining. As Nobel laureate Harry Markowitz once said, “diversification is the only free lunch in investing.” So, it’s important to ensure your allocation between equities, fixed income, and alternatives (like gold), are well positioned and dialed into the right range. Having tools that can work in different environments can help prepare you for what’s to come.

Please contact your BMO Global Asset Management wholesaler for any additional support and guidance.

¹(2024, April 6). S&P/TSX composite up more than 300 points in broad-based rally, U.S. Stocks also rise. Canadian Press.

²(2024, June 13). CBOE Volatility Index (^VIX). Yahoo Finance.

³(2024, May 17). VIX Index Closes at Lowest Since 2019 as S&P 500 Grinds Higher. Bloomberg.