TUESDAY, 28 FEBRUARY 2023

OPINION

Markets Insight

Risk management is the alphafor a time of uncertainty
After two decades of easy money, investors will haveto manage portfolios with almost constant market
challenges ahead
TERRY DUFFY
Well, it was fun while it lasted. Twodecades of easy money with low tozero interests, further juiced bysuccessive rounds of ever larger stimulus spending, turned prudent investment principle on its head.
Scores of novice investors flocked
into the markets with the belief thatbuying every dip was a masterclassstrategy to guarantee profit. That’s
understandable; when there is only
upside, it’s easy to be fooled into
thinking flash can replace knowledge
and that gimmicks can substitute fordiscipline.
But the events of 2022 poured cold
water on that exuberance. During thepast 12 months, we experienced thebiggest interest rate shocks in recentmemory. High inflation hurt equities
and debt markets, negatively impacting businesses and consumers worldwide. At the same time, China’s
Covid-19 lockdowns stifled demandand choked production and Russia’s
war against Ukraine sent energy andfood prices skyrocketing.
As the quantitative easing support
programmes for markets from central
banks give way to quantitative tightening, myriad emerging headwinds
have increased uncertainty on a
global level.
Risk management is the alpha — thereturns above market benchmarks
derived from investing skill or choice.
In this environment, what were once
considered to be 100-year events havebecome everyday occurrences. As aresult, risk management has been
elevated from a supporting player tothe star attraction.
With fears of job cuts and possible(or possibly not) recession ever present, higher prices and consumer
caution the new norms, relying on the© THE FINANCIAL TIMES LIMITED 2023

“same-old, same-old” investment
strategies is not only not an option,
but the riskiest strategy of all. Effective risk management is what can
provide above-average returns toactive, passive and everything-in-between investors. That’s why we areseeing a flight to futures, as some of
today’s most important trades are tomanage risk.
No guarantees, but hedging canprovide certainty. Considering whatall investors are up against, there areno havens. Despite economic risks,
the US central bank shows no indication of changing course until inflation
falls closer to its 2 per cent target.
Around the world, uneven responses
by central banks to tamp down inflation have added to uncertainty andfluctuating exchange rates, all while
the market adjusts to a rapid shift
from the Libor benchmark forborrowing to Sofr, or the Secured
Overnight Financing Rate.
Commodities are not immune
either. US food costs rose last year totheir highest levels since 1979. Persistent concerns of global economic
weakness continue to have an impact
on global energy demand, creating
price volatility. That’s also true inmetals markets, where geopoliticalevents could compound the imbalance in supply and demand for minerals vital to an energy transition.
We can never lose sight of the roleinnovation plays in shaping financial
markets and, in turn, growing business and economies. This is critical inenabling new businesses to sell debt
and raise capital to fund expansion
opportunities, bring ideas to market
and develop new products, all ofwhich create jobs and facilitate theevolution of industry.

But not every idea is a good one — asobering fact that was less obvious in
the recent environment where theelevator only went up and everyone
could seemingly get to the penthouse.
Innovation needs a use case that
demonstrates purpose, solves a problem or creates a benefit. Without that,
it is merely noise.
Smart regulation is fundamental.
Customer protections must always
take centre stage. Markets like clarity,and they work best when clear rules
and common standards are in place,transparent and understood by all.
Likewise, counterparties and market
integrity matter a lot. During the last
couple of years as trading in meme
stocks took off and the fear of missingout replaced due diligence and bestpractices, the extraordinary collapseof new assets such as cryptocurrency
once again reinforced the reality wealready knew: strong, effective regulation is non-negotiable.
Looking ahead, we can expect awhirlwind of geopolitical andeconomic hurdles to continue. For
markets, that means it will be evenmore difficult to determine the highsor the lows. For investors it will mean
managing portfolios with the best
information out there, knowing it
may all change. With near constantmarket challenges ahead, effective
risk management will be crucial. To
navigate this new age of uncertainty,
expecting — and planning for — theunexpected could be the differentiator that separates disciplined investment strategies from distractions.
The writer is chair and chief executiveof CME Group