Worried About Volatility? Three Targeted Moves for Cautious Investors

Following two years of exceptional stock market performance for the S&P 500—and with valuations nearing their richest level in decades—some of our clients are exploring strategies to lock in some of their gains. What’s more, as we move into 2025, US markets have mainly run in place, unsettled by ongoing geopolitical events and an unusually high degree of policy uncertainty emanating from Washington, DC.

We remain optimistic about the overall economy, driven by a strong labor market and steadily increasing after-inflation incomes that are powering consumption—the enduring engine of the US economy. As long as these factors hold true, they should continue to support companies’ earnings growth, and with that, the stock market’s long-term returns.

Ultimately, time in the market is more valuable than trying to time the market, in our view. Yet a few opportunities currently stand out for those looking to reduce their risk in an informed way.

Buffer the Uncertainty

Recently, and especially over the past few months, our clients have found significant value in the risk management benefits offered by buffered ETFs. These strategies, which vary in the particulars, tend to use a package of options on the S&P 500 to allow investors to capture meaningful upside market moves while limiting their exposure to losses beyond a preset “buffered” threshold (Display).

This dual ability to participate in gains while offering some downside protection can be quite appealing in times of elevated uncertainty. In addition, unlike other hedging strategies that are indirect—and may not effectively shield against market shocks—these strategies are directly tied to the market. Their returns and the degree of protection they provide are entirely dependent on their structure and the market’s performance during a given period.

Focus on “Alpha”

Hedge funds represent another compelling solution in today’s markets. But keep in mind, their performance can be more variable compared to buffered ETFs. Market conditions, the opportunity set available to generate above-market returns, and the blend of skill and luck that managers employ will all play a role.

What’s more, while buffered ETFs reduce an investor’s overall exposure to market fluctuations (known as lowering the “beta”), hedge funds offer low-beta market exposure with added reward potential. That’s because hedge fund managers aim to enhance returns (i.e., add “alpha”) by using active stock-picking, macroeconomic forecasting, or other skilled approaches to beat the market.

Unlike the programmatic nature of buffered ETFs, both the “beta” and the “alpha” of hedge funds can vary over time. But over the medium and long term, skilled managers are expected to deliver slow and steady alpha-driven returns while maintaining minimal market exposure and a low correlation with other asset classes. That combination makes hedge funds attractive additions to portfolios as they seek to improve risk-adjusted returns.

Differentiate Your Fixed Income

Right now, fixed income markets offer a particularly appealing angle. Interest rates sit above their pre-pandemic levels, creating a solid starting point for investors. And while municipal, Treasury, and corporate bonds tend to dominate most bond market investments, the securitized asset space shines today, with a distinct and intriguing risk profile.

Securitized yields are holding their own against other investment areas, especially given their relatively short durations. More importantly, the returns from securitized assets are driven by a different sector of the economy—US households—which are currently in sound shape with a strong outlook. Plus, mortgage-related debt, including agency debt and credit risk transfer (CRT) securities, exhibits a relatively low correlation to other asset classes, making it a valuable diversifier in uncertain times. And the floating rate nature of CRTs and CLOs (collateralized loan obligations) can effectively complement a portfolio of fixed-rate bonds, especially in a scenario where upward pressure on long-term rates persists.

Interestingly, while policy uncertainty is largely viewed as a downside risk in other areas, it could actually serve as a tailwind for these assets. Deregulation policies that reduce capital requirements for banks might spur increased demand for these securities from the banks themselves. And the long-sought re-privatization of Fannie Mae and Freddie Mac by many Republicans could lead these agencies to bolster their capital reserves in advance, potentially reducing CRT issuance to do so. Lower issuance would likely cause existing CRTs to trade at more of a premium, enhancing their appeal. (Display).

Fine-Tuning for Volatile Markets

In the world of investing, there’s always an action to take, but often, the best move is to do nothing at all. By and large, we aren’t overhauling portfolios today.

However, for clients concerned about policy risks and heightened geopolitical and macroeconomic uncertainties—especially those who have enjoyed substantial stock gains over the past two years—a few areas stand out. Any portfolio moves should be deliberate, targeted toward these fertile grounds, and modest in scale. Ultimately, for those tinkering at the edges, it’s worth considering buffered ETFs, hedge funds, and securitized assets in today’s environment.