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Wall Street gurus: How to invest in a volatile market

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Throughout the pandemic, the stock market soared against all odds. Now the fun might be over: The Russia-Ukraine war and rising inflation recently prompted the Federal Reserve to order the largest interest rate hike in more than 20 years. Stock prices have begun to plummet accordingly.

How can investors navigate this erratic landscape? At an MIT Sloan event in New York on April 14, professordirector of the MIT Laboratory for Financial Engineering, sought counsel from a slate of finance experts featured in his book, “In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest.”

The panel included Nobel Prize winnerPhD ’70; Wharton finance professor Jeremy Siegel, PhD ’71; and investment consultant Charles Ellis. The talk was moderated by Kathryn Kaminski SB ’01, PhD ’07 and Mila Getmansky Sherman, SB ’98.

Here are their candid thoughts for investing in a volatile market.

Be wary of target date funds

Setting and forgetting is fine for a crock pot; less so for a perfect portfolio. Both Ellis and Merton warned against them.

“The basic proposition that target dates tend to follow is awfully damn close to ‘put your age in bonds and the rest will work out pretty much fine’ — and that is baloney,” said Ellis, a former managing partner at Greenwich Associates and author of “Winning the Loser’s Game.”

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“This is an investment strategy that never updates. … It never uses new information about you or the markets,” said Merton, a distinguished professor of finance at MIT Sloan. “If that were good enough to get you to a good retirement in 10, 20, 30 or 40 years, those of us who are in the financial service business really should look for another profession,” he quipped.

Look for opportunity in crisis

“It’s those precise moments where having a diligent approach, divorcing your emotion from your action, when you can actually find interesting opportunities for portfolios,” said Kaminski, chief research strategist at AlphaSimplex, a quantitative investment firm.

She’s coined the term “crisis alpha” to describe investment strategies that generate positive returns during market stress. In essence, crisis alpha is profit gained by exploiting persistent trends that occur across markets during times of crisis.

“When things are really difficult, like they are right now, it’s actually important to have strategies in your portfolio that are willing to forget the past and move to the future,” she said.

Insurance is important

“There are three ways to manage risk: diversification, hedging — that’s the risk-free asset — and insurance,” Merton said.

“In both the institutional as well as the retail space, the first two are overwhelmingly what is used. Very little is done in insurance. That’s crazy,” Merton said. “Insurance is going to be a big area — helped by technology, helped by markets, and [helped by] the fact that it’s damn hard to get alpha.”

Don’t overlook value stocks

Siegel is a fan of index funds; he also favors value stocks — that is, stocks with prices that appear low relative to the company’s performance.

“If you tilted your portfolio in that direction, you would have a slightly better risk-return tradeoff. ... I own a lot of cap-weighted [funds], but I still believe in a tilt,” he said. “It’s really because I don’t believe the economy is efficient. You have to have active investors. You can't have a perfectly efficient market. No one would do any analysis, and you wouldn't have [value] prices.”

Speaking on CNBC the previous month, Siegel said: “I think we have a rotation toward value stocks because they’re shorter duration; they’re not going to be affected by these interest rate hikes as much.”

Think more holistically about your total portfolio

Ellis also urged the audience to think more broadly about what constitutes a portfolio.

Investors tend to “ignore an enormously important set of consequential factors and concentrate everything on one small fraction: the securities part of their portfolio. They don’t have any idea what their Social Security is worth in net present value,” he said. “It's not very hard to figure out.”

What’s more, younger people often neglect to factor in future income and potential intellectual property, or forget to factor in their homes as part of their worth.

On the flip side, Ellis is not a fan of bonds.

“Everybody in this room, and almost every investor you will ever meet, is way over-invested in fixed-income securities,” he said.

Watch: In pursuit of the perfect portfolio panel discussion

Watch: Video Interviews with 10 investment luminaries

For more info Tracy Mayor Senior Associate Director, Editorial (617) 253-0065