UBS Global Wealth Management is urging investors to use strategies including structured solutions, specifically barrier reverse convertibles (BRCs) and options plays, to prepare for a more volatile bull market.

In a research note, Volatility is back. Are you prepared?, the UBS chief investment officer said that based on how UBS GWM clients have positioned themselves, many investors are relying too much on passive approaches in traditional markets; not managing equity downside risks appropriately; focusing on higher yields and underestimating risks; are concentrated in assets in familiar regions/industries; and are not thinking sufficiently long term.

Recent years have seen strong performance for investors holding traditional balanced portfolios of equities and bonds, according to Mark Haefele (pictured), chief investment officer at UBS Global Wealth Management. Haefele believes that those investors properly diversified have well-equipped risk-managed portfolios for the new market environment although many investors are entering this higher volatility environment ill-prepared.

"The bull market in 60/40 equity/bond portfolios is the longest on record, with annualized returns of around 10%," said Haefele. "But as we enter a higher-volatility environment, generating return and limiting risk will require investors to look beyond traditional strategies. At points of market uncertainty over interest rate policy, correlations between equities and bonds can rise, increasing the volatility of traditional equity-bond portfolios, making returns less certain."

Haefele also noted that while a negative correlation between bonds and equities will persist over the medium to long term, "periodic jumps in correlation means that strategies that are less correlated to equities and bonds become important for reducing short-term portfolio volatility".

To prepare for the new environment, UBS believe investors will need to diversify beyond classic equity and bond indexes (e.g. via smart beta and buy-write options strategies); reduce equity market downside and retain upside (e.g. via barrier reverse convertibles and buying put options); diversifying income away from risky credit and/or FX exposure (e.g. via dividends, extending duration); diversifying by sector and country (e.g. via overseas and domestic investments with greater overseas exposure); and investing in longer-term approaches.

Barrier reverse convertibles can be useful in times of higher volatility since they can provide investors with greater "predictability" of returns, according to Haefele. "During periods of higher volatility, available yields and coupon rates on BRCs can improve, since implied volatility increases. Furthermore, rising interest rates can increase the coupon since investors require higher compensation for funding the issuer," he said. "Although barrier reverse convertibles may not be suitable for investors looking to protect against large drawdowns (such as those seen during the 2008-09 financial crisis), they can still deliver positive returns when underlying assets suffer smaller drawdowns. And they have historically seen smaller drawdowns than underlying equity indexes."

In a portfolio context, BRCs can also add value by improving diversification and reducing portfolio volatility, according to Haefele. "The most consistent returns are achieved when a BRC investment strategy is executed consistently and systematically," said Haefele.

SRP data shows that there are more than 89,500 barrier reverse convertibles (BRCs) have been marketed across jurisdictions of which 16,642 are still live. Switzerland dominates the issuance of barrier reverse convertibles (BRCs) with Vontobel (10,609 BRCs), Leonteq (2,963 BRCs), Credit Suisse (703 BRCs), Raiffeissen Switzerland (678 BRCs), and Julius Baer (580 BRCs), as the main provider of these products. UBS is also an active provider of BRCs and has 457 live BRCs in the Swiss market.

Zurich Insurance Group (1,222 BRCS) is the stock featuring in the highest number of BRCs followed by the Eurostoxx 50 index (1,117), Swiss SMI index (1,064), and S&P 500 (1,063).

Click in the link to read the UBS GWM CIO Volatility is back. Are you prepared? Report.

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