Asset managers are warning investors to expect increased market volatility heading into the US elections next week as polls are not pointing to a clear favourite at this time, as well as volatility even after the elections as markets digest the results.

While market volatility is not expected to substantially impact the strong market fundamentals that are currently driving the financial markets, investors are being advised to diversify and hedge their portfolios to offset potential losses in the event of a prolonged volatile environment.

“Despite the volatile and often heated rhetoric of the US election campaign, it is unlikely that the election outcome will derail the drivers that have propelled global stocks higher over the past two years. Even in the context of election uncertainty, we continue to view global equities as attractive. Still, the election could create short-term volatility, and investors can consider hedges to insulate portfolios,” according the latest report on the US elections issued by the UBS Global Wealth Management Chief Investment Office.

The report, which lays out various scenarios for a win by either US vice president Kamala Harris or former US president Donald Trump, also explicitly warns investors “do not mix politics with your portfolio”.

“This advice has so far proven to be sound despite the palpable angst over the election result, a global 60/40 bond portfolio has returned an impressive 11% year to date,” says Solita Marcelli, chief investment officer Americas, and Kurt Reiman, head of fixed income, CIO Americas, both of UBS Global Wealth Management, in a letter to their investors.

Other managers also warned against market volatility with Benoit Anne, managing director, strategy and insights group, MFS Investment Management, saying in a separate statement that the rate of volatility, which is already quite high, may pick up even further should Trump win the presidency and the Republicans win Congress.

“There is a risk that rate volatility may rise further because of the US election. It is all about initial conditions. We are entering the last stretch of the election campaign with a US economy that is doing particularly well. Some might even say too well, given that recent macro performance does not appear to be sustainable. In the event of a Republican sweep, and if the policy agenda looks like what has already been announced, there is a clear risk of the US economy tipping back into a higher inflation regime by adding fuel to the inflation fire through supply shocks, higher tariffs and demand stimulus,” says Anne.

Close monitoring

Portfolio diversification is the key strategy in the wake of the market volatility that’s coming with the US election.

“In the coming weeks, we will closely monitor bond markets and their capacity to diversify equity risk in the event of a sell-off. Should investors perceive that the new government threatens the "soft landing" and immaculate disinflation trends we've seen recently, yields may rise, and equity-bond correlations could spike again,” says Claus Vorm, Sr., portfolio manager and deputy head of multi assets at Nordea Asset Management (NAM).

Vorm says that in this scenario, NAM’s alternative risk premia strategies across equities, fixed income, currencies, and cross-asset markets will be well-positioned to provide much-needed diversification for investors.

“Alternatively, if the election outcome is positively received by the markets and we see a continuation of normalized correlations, we expect mid-to-long-term returns across our portfolios to be very attractive, given their fundamental strength and relatively favourable valuations,” Vorm adds.

Thomas Smith, portfolio manager and member of the emerging market debt team at MetLife Investment Management (MIM) public fixed income, who also manages NAM’s emerging market bond strategy, says because of the expected volatility heading into the election, his team has reduced some overall risk across emerging market portfolios to lower the tracking error relative to corresponding benchmarks.

“We want the ability to be a buyer if we experience any disruptive outcomes. In the meantime, we have been focusing on high conviction credits, including select sovereign rising star candidates which we believe can benefit from further spread compression,” Smith says.