Risk-reward balance: investors now battling with multiple uncertainties

0:12How do we explain the way markets work to potential clients? Granted, most people have seen the risk warnings on their investments. Capital at risk is a common phrase, but what does that actually mean? And how would you respond to a curious client who wants quite rightly to understand why markets are behaving as they do. On this episode of Margin Notes, we're going to unpick why markets are behaving so bizarrely over the past 12 months or so. I'm Simony Kiriakou, editor of FT Advisor, and our guest today, Violetta Todorova, is the senior research analyst at Leverage Shares. She's been exploring the theme of risk herself for many years.

0:51She specialises in technical analysis, macroeconomic research and equity markets. And if anyone can unpack anything that's been happening lately, she can. Welcome, Violetta. Thank you. Thank you for having me. That's a pleasure. Thank you. Let's get straight into it. How do we define risk, especially when it's behaving so idiosyncratically as it has been in the past few months? That's a very good question, actually. And usually investors associate risk with volatility, which in my view, this is incomplete when we talk about risk. Previously, generations ago, market risk or risk altogether have been changes in interest rates, currency movements, recessions, geopolitical shocks, wars, and etc.

1:42While nowadays I think risk is definitely becoming more idiosyncratic and especially 2026 is a very good example of that. And what do I mean by idiosyncratic risk is basically risk that cannot be easily, it can be easily diversified away. So once we identify it, we can reconstruct the portfolio and avoid it or reduce that risk as opposed to market risk, which like in a recession, all assets fall down and investors don't possess too many tools to diversify or reduce that risk. So what I'm seeing in 2026, the risk really becoming idiosyncratic is a handful of stocks are beginning to dominate the index.

2:43Like looking at the S &P 500 or the Nasdaq, we would have a handful of companies which are driving earnings for the entire market, the majority of earnings. So once upon a time, we would diversify our portfolios just by adding exposure to the index. While nowadays, buying the index, an ETF of an index, is just giving us a concentrated exposure to a handful of stocks. So that's why we can't diversify that way. And investors and clients have to deal with that problem and really focus on how to diversify their portfolios. And that's a big question, isn't it? Because, you know, I think it was about 20 years, maybe even 30 years ago, Warren Buffett famously said, if you want to start investing, buy the S &P 500 and hold it.

3:42But at that time, we didn't have such high market capitalization of just a few stocks. We didn't have the index completely skewed with massive overweights in just one sector as well on that index. so we're sort of seeing that if you do just buy the S &P 500 you're basically buying the you know the mag 7 so that's that's a difficult um that's a difficult one for for investors because they're unintentionally starting out by having overly exposed portfolios to the tech sector which they may not have actually wanted to have in the first place so you know that that That can be quite a worry, I guess.

4:21Then again, we have people who don't have advice, who probably wouldn't know about sort of getting equally weighted index, holdings and portfolios or equally weighted ETFs. So it's understandable that people would be wanting to capitalize on all the momentum that's growing because money is good and greed is good. But it does feel, it feels a bit scary, don't you think? A little bit too toppy? look if you're asking about if the market is a little bit too toppy if that is is that the question you're asking me or if should investors be fearing this sexist market risk yeah i mean it's a bit of both really because yes is the market toppy but do we need to fear it you know what's what's the valuation saying you know really getting under the bond of it do we need to be afraid of market risk we need to be afraid of the mag 7 this is a very good question and i guess There are a couple of layers that we can touch on before we answer completely the question.

5:22So over the past three years in the industry, I'm seeing a lot of investors actually trying to manage risk by themselves. Although they would have, I come from traditional broking background, investors would be having an advisor which will construct portfolio. But advisors were not only constructing the portfolios, they were actually mentoring their clients because clients usually associate risk with volatility, with market volatility. And they would want to eliminate this risk and try to be a little bit more active in their portfolios. So what inevitably and most often is happening is traders or investors will be selling after the market already started selling off and buy back when the market has already rebounded.

6:28And if we compare a long-term investor that has been holding its portfolio with, of course, some adjustments over the years, over 30 years, for example, and withstanding the volatility in the market because volatility is part of market behavior, I think a long-term investor would have actually much better results than someone trying to proactively manage the portfolio to eliminate that risk driven from the volatility. So I think time horizon, it's very important. But of course, if we have a 30 year old investor that is building a portfolio to retire on, it will have very different goals than a retiree, which is just about to start drawing down funds in a couple of years.

7:24So all those considerations are there. Another point I want to make before we move to the other part of your question is why I don't really agree that risk should be defined as market volatility. Let's have two examples. For example, a bond, a bond that is very, very volatile, but if held till maturity, it actually has very limited risk. But on the other hand, if an investor wants to eliminate the volatility in the market and goes into cash, which is a very low volatility investment, I think this low volatility, it is actually carrying much bigger risk because I think at the end of the day, holding cash for five years, it has almost certainty is going to lose purchasing power for that investor and he will fail to meet his obligations.

8:30So to answer the other part of your question, should investor fear it? I will try to answer it a little bit more balanced, but I think investors should appreciate it, recognize it and deal with it rather than fear it. Because risk is part of equity returns. And by being invested in the market, we want to be paid an extra equity premium for carrying this risk. So once we understand why we are paying significantly higher than cash holdings, then we can answer, Bera, should we fear the risk or we want this risk and be paid down the road? And perhaps one final example I would give you, because the timing is really very crucial here, Simone.

9:25If we look at the market, if we have market data starting from 1940, and we observe how equity indices have been moving, of course, we will see that 70 years later, the markets globally are significantly higher, significantly higher. So I think in a 30 years time horizon, if we start investing, most probably we will go through a couple of bear markets, which will feel extremely painful at the time. But if we are disciplined, we hold our holdings, I think at the end of the day, that volatility is paper loss. It's not a realized loss. Yes, you haven't crystallized it. And exactly right. So I think those bear markets, in my view, are providing great buying opportunity and we should use them.

10:20Pullbacks, corrections, bear markets are providing us with opportunity to add more equity into our portfolio and continue riding the wave. I think that's a very good way of explaining it, you know, particularly though you mentioned, you know, the difference between a sort of 30 year old who's really trying to sort of grow their portfolio for when they're 60 versus a 60 year old who's thinking I'm going to retire and start drawing down. you know volatility is going to be one person's friend there much more than it's going to be the other person's friend but that's that's the whole part of the advice process isn't it to work out maybe you both the 30 year old and the 60 year old say well we're a bit risk averse we're not very tolerant to risk but actually if you explain it to a client at 30 your funds can tolerate a lot more volatility don't be afraid of it but then when it comes to 60 well let's actually look and see what your options are really do you want to go into cash because you're going to have that purchasing power as you say that's going to be eroded inflation's going to get in maybe let's think about other things that we can do i'll just maybe stay invested do a bit of drawdown it's it's not easy it's not easy but again it just depends on each person doesn't it but i think recently we've also found it i think a bit harder to find that sweet spot between risk and reward haven't we because there's been so much uncertainty you know people who'd use gold or currency gold or commodities as a hedge suddenly found that they were doing very well it was behaving extraordinarily well in sort of february march april and then suddenly it's not yeah it's it's very hard i think sometimes isn't it because we've got that that risk reward balance it's really hard to find that sweet spot this is a very good point you're making here, Simone.

12:09And I think every generation is having the feeling that is going through a period of great uncertainty. I mean, years ago, investors had to withstand world wars, but the market still existed and they recovered very successfully after that. And I think why we are feeling it more pronouncedly now is that over the past 20 years, 10 years, say, we lived in a ultra low interest rate environment with very low inflation, abundant liquidity, and investors got it for granted. They didn't have to deal with that at all. While after the COVID pandemic, all those given things have changed and investors have to actually adjust their portfolios accordingly.

13:09But the best example is what's going on in 2026. We have a geopolitical shock, which is triggering an oil shock. So instead of investors focusing how to deal with the geopolitical and oil shock, a lot of things unfolded simultaneously after that. Then we have inflation rising up, bringing the hawkish rhetoric from the Federal Reserve. So if we have interest rate hikes on the card, equity valuations get impacted straight away. So it is becoming not one uncertainty that clients or investors have to deal with, but there are a few unfolding simultaneously. And I think this is where the role of the advisor comes, helping investors navigate those uncertain times.

14:10Although I wouldn't be worried about uncertainty because there is always some degree of uncertainty in the market. So as long as investors become comfortable with that uncertainty and they construct their portfolio according to what they know at the moment and they have a long enough time horizon to achieve their investment goals, I think this is totally fine. And I guess if we know, okay, we are going through a geopolitical and energy shock. Yes, that is very important what happened in March. We've seen a market sell off. But if we ask ourselves, would that impact my portfolio in five years or in 10 years?

15:01I think this will just give us the comfort that this is just the short term volatility. but equity markets long term are going to do what they usually do and it's going up. And in terms of equity markets we've seen a lot of interest renewed interest in emerging markets but if the Fed gets a bit more hawkish you know sometimes whatever happens in America they say if America sneezes the rest of the world catches a cold. Emerging markets have always been very sensitive to anything that happens in the US. Is there a concern that people diversifying their portfolios into emerging markets right now could end up still being affected by what happens in the US?

15:44Absolutely, Simone. I think what you said just summed it up brilliantly. And that is the case still today. And it has been many years ago. So the comfort I'm getting here, though, is that despite the extremely overvalued, expensive US market, I don't think we are at the point where a major bear trend is coming. I know investors are concerned with valuations and how expensive stocks are. And I get asked a lot about AI bubble. Are we building a bubble? Is the bubble bursting? And I've been asked for just about a year the very same question. Equity markets keep going up. And I'll draw one comparison back to 2000 during the dot-com.

16:41We had very similar indications in 1996 that the market is becoming stretched, very expensive, momentum, hype, driven. But the bull market extended for another four years before the bubble eventually burst. So focusing back in 2026, we are starting to see similar dynamic. The market is becoming very expensive. It's driven by technology. Valuations are absurd for some sectors. And it is natural to ask yourself because we don't want to buy expensive stocks. This is part of the risk management. But I think we are still a few years away. And I will just put a little bit of comfort to defend my argument.

17:34If we look at what happened in 2000 and 2008 during the GFC, interest rates were significantly higher. And I know investors are now worried with the new Fed chair suggesting and changing the rhetoric completely. He sounds a little bit more hawkish. We are expecting at least one interest rate cut this year. And also he's cutting forward guidance, which is a big problem for investors that got used to get news which digest all the implications. Now they have to do the homework themselves. So even if we don't see inflation subsiding from here, although I think oil-related inflation will start gradually subside, but given the massive AI capex we are witnessing, that will keep inflation higher for longer.

18:32so I can't see interest rates rising to the level during the GFC in 2008 and 2000 so I think we have a few more years to enjoy a strong bull market underpinned by very strong valuations if we look second quarter earnings are approaching globally we are expecting 25 % earnings growth. That's significant. That is likely to underpin equity markets. And just think about it from that perspective. In first quarter, when the war in Iran just started, we had a very short and sharp sell-off. But equity markets have rallied 20 % from the March low. And that rally, it's underpinned by earnings growth. And we are going to see something very similar in the second quarter.

19:34So I think equity markets are going to be resilient and buying opportunities will emerge every time we see a good pullback. And we've seen quite a few high-profile IPOs. It looks like more companies are coming back to the market or coming back to international markets to list, which gives a nice bit of fresh impetus, I guess, to investors. It's nice to see companies listing. But could we then just unpick a little bit more about the data, the macro data on equities? Are there certain sectors in the global equity markets where valuations perhaps look a bit stretched? And are there certain areas where valuations look like they could go a bit further for a lot longer?

20:25Look, I think as of now, the healthcare sector is looking very, very attractive after a couple of years of underperformance. And I think that pocket, it's looking very interesting right now. Industrials as well. Okay, with AI-related stocks, some stocks have very, very high valuations right now, which is concerning a lot of investors. But I think AI stocks or tech stocks as a whole will continue to drive market returns in the next year or so. So it really depends. We see with tech earnings momentum and price momentum, while with the laggards for now, we have very attractive valuations. But the big question is when are those stocks going to turn the corner and start enjoying the price momentum?

21:35I would be very comfortable to start accumulating or just chipping in in health care globally. there are so many good stocks which are significantly undervalued. And that is a sector I would be particularly interested in. I think within the next 6 to 12 months, potentially we can see them just turning the corner. Yeah, I mean, that's really interesting. There's a lot of biotech, meditech, pharma tech coming up. in the UK as everywhere. Very interesting companies, smaller companies wanting to start listing and start making their inroads. And as a global population, there's more human beings with more health problems, greater longevity across all nations.

22:30We're going to need healthcare. It seems like it's, in that sense, the thematic trend is backing healthcare. Whether I still want to be playing around with AI when I'm 90. I don't know, but I'd certainly like to have some pills to take. Absolutely, yes. Well, Violetta, I mean, I could talk to you about market risk all day and we could get into all sorts of things, but I know that the podcast studio is just about to be taken over. So sadly, that is all we've got time for. Thank you for having me. No, thank you very much, Violetta, for coming in and talking to our Margin Notes audience. And thank you for listening.

23:10For more investment news and views, stay tuned to ftadvisor.com. And until next time, take care.

23:36Still waiting in line? Again? That's time you'll never get back. Save time and money with Stamps.com. Over 4 million businesses have skipped the line with Stamps.com. Join them to save up to 90 % off carrier rates from your computer or phone right now. Print postage for certified mail, registered mail, and packages in seconds. Then schedule a pickup right from your home or office. For a limited time, go to Stamps.com and use code PODCAST for a free welcome gift. Taxes and fees apply. Do you keep hearing podcast ads, like this one for example, but always wonder how you actually get involved with them for your own brand or organization?

24:14Well, it's easier than you think. We're Acast, and we give you the platform to do it all yourself. Browse thousands of popular podcasts, choose the shows that match your perfect audience, set your budget, and launch. And if you want a hand, our podcast specialists are there to help you launch with confidence. This is podcast advertising without barriers. Get started at acast.com slash advertise.