• Unanswered questions on US trade tariffs are creating uncertainty in markets, resulting in higher volatility.

• Uncertainty, though, can lead to disruption, which may present an investment opportunity.

• Every downturn, disruption or period of uncertainty has the potential to unlock opportunities to either mitigate risk or drive outperformance.

Ongoing tariff negotiations leave many unanswered questions, adding to uncertainty in the markets. Uncertainty can be unsettling, no doubt, particularly for investors in countries impacted by the proposed tariffs, and it can lead to greater volatility as the markets process the news.

Uncertainty is nothing new. Having been in the investment industry for nearly 30 years, I’ve faced uncertainty in the markets many times, navigating downturns and upswings. We should look at uncertainty beyond its potential for volatility - it also highlights opportunities to either mitigate risk or drive outperformance.

Diversification to mitigate risk

Mitigating risk is the more apparent issue for investors. With rare exceptions, fixed income has generally provided ballast against equity risk. Moreover, as our economists have pointed out, bonds are particularly attractive in today’s environment where interest rates generally exceed the average rate of inflation. Given this outlook for bonds, as well as the stretched valuations for some equities, a balanced or multi-asset portfolio looks more prudent than it has in decades.

Let’s not forget that diversification should not be just across asset classes but also within each asset class. The potential impact of tariffs will be uneven across regions, sectors and companies, with the ripple effect unknown. Investors’ natural tendency for home bias may be particularly counterproductive in an environment where we expect greater dispersion of returns.  Globally diversified portfolios—not too concentrated in any one region or sector—are better suited to mitigate risks.

Harnessing disruption to generate alpha 

Uncertainty can lead to disruption. In theory, periods of disruption should be an advantage for active managers. Greater volatility translates to greater dispersion of returns and more opportunities for active managers to add value relative to benchmark indices.

In practice, that doesn’t always happen, often because managers ‘swing for the fences’ by taking on undue risk to deliver returns above their costs. Adding value, especially during periods of disruption, requires skilled, low-cost active managers who can make judicious security selection without the pressure of having to compensate for their fees.

This is particularly true in the fixed income market. There are more than 30,000 unique securities in the Bloomberg Global Aggregate Index. This presents both a larger opportunity set and an imposing challenge for bond portfolio managers. Those with access to specialised teams providing deep credit research and insights have an advantage in being strategic and opportunistic.

I should add that the advantages of credit research and proprietary insights can span to index funds, as well. Because bond indices typically have thousands of securities, full replication in a real-world portfolio is impractical. Bond index funds that use sampling techniques can use credit research in picking which bonds to include and, more importantly, which bonds to exclude. (Avoiding the losers can make more of a difference to performance than just picking the winners.) This approach further helps consistency in performance over the long run and over many market cycles.

Costs change the risk-return profile

Low costs also have a further advantage at many levels, for both active and index investors. The obvious one is that costs directly detract from returns, and they do so proportionally more for bond portfolios than for equity portfolios. Keeping costs low is important for any investment, especially for bonds.

A less obvious but more important advantage is that with lower costs the same level of expected return can be achieved with less risk. Framed differently, higher-cost managers will feel compelled to take on greater market risk to deliver higher returns above fees. This can be particularly dangerous in a volatile market environment.

On the other hand, skilled, low-cost active managers can be both prudent and opportunistic during times of turbulence, acting on only the most attractive investments and passing on those that carry undue risk. In other words, they take on only smart risk, with no need to compensate for a higher expense ratio.

In my nearly three decades in the investment business, only a few themes have stood the test of time. One of them is: Every downturn, disruption or period of uncertainty has also unlocked opportunities.