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One of an advisor’s hardest jobs is to keep their clients on track when the markets are volatile and the news fills with frightening headlines.
There is a human, knee-jerk reaction to defend your investments during these times. Many clients have a straightforward understanding of defensive investing: “Reduce my equity exposure and avoid risk.”
In practice, it is more complex than that. Defensive investing hinges on knowing where risk comes from. You can’t avoid it, because risk is the price of admission for returns. But you can manage it.
It’s worth noting that risk doesn’t always mean price movement. Market risk reflects broad movements across asset classes. Credit risk relates to the ability of an issuer to meet its obligations. Duration risk captures sensitivity to interest rates. Volatility influences how those risks are experienced over shorter periods.
There is also behavioral risk. Investors who do not understand how a portfolio is expected to behave may react at the wrong time.
Recognizing these differences is important. It allows each part of a portfolio to be managed with the appropriate tools.
The actual work of managing the different types of risk looks very different across asset classes, even though the underlying goal might be consistent.
In equities, the focus is on managing downside at the position level. That includes limiting losses when a position breaks down and maintaining discipline when the original thesis no longer holds. Over time, avoiding large losses has a meaningful impact on overall results.
In fixed income, defense is built into the structure of the portfolio. Factors like credit quality and maturity schedules shape how the portfolio responds to changes in interest rates and market conditions. A laddered approach, for example, helps manage reinvestment risk and reduces sensitivity to any single point in time.
Equity Risk Is Managed Through Selection & Discipline
Equity portfolios are exposed to both company-specific outcomes and broader market volatility. That creates a wide range of possible results, which makes risk management a continuous process rather than a one-time decision.
A central focus is limiting the impact of losses. That often means exiting positions when the original thesis no longer holds or when price behavior signals that something has changed. This is not the same as panic selling. Here’s why.
Not every declining position is treated the same way. In a fundamentally driven portfolio, a stock may be held through a period of weakness if the underlying business remains intact and the long-term outlook has not changed. In a more rules-based or technically driven approach, the same position might be reduced or exited more quickly, with the option to re-enter later if conditions improve.
This distinction reflects different methods, but the objective is consistent. Risk is managed through disciplined decision-making rather than prediction.
Over time, results are shaped less by identifying perfect investments and more by managing the outcomes of imperfect ones. A portfolio that avoids prolonged exposure to large losses is better positioned to benefit from the investments that do work as expected.
Fixed Income Risk Is Managed Through Structure & Sensitivity
Fixed income portfolios operate under a different set of risks. Interest rate movements, credit spreads, and sector exposure all influence outcomes. Managing those risks starts with structure.
Duration is one of the primary levers we can use to control risk. It determines how sensitive a portfolio is to changes in interest rates. Portfolios are often positioned relative to a benchmark, with small adjustments based on market conditions. If rates are expected to move higher, duration may be shortened to reduce price volatility. If rates are expected to decline, duration may be extended modestly to capture additional return.
Credit spreads are another key factor. A high-quality corporate bond may offer a yield above Treasuries, reflecting the additional risk. That spread can widen or tighten depending on market conditions. Monitoring those changes helps determine where to take on risk and where to reduce it.
Portfolio construction also plays an important role. Many portfolios are built using a laddered structure, with bonds maturing at regular intervals over time. As those bonds mature, proceeds are reinvested at current market rates. This helps manage reinvestment risk and avoids concentrating exposure at a single point on the yield curve.
Sector allocation adds another layer of control. Treasuries, agencies, corporate bonds, and municipal bonds each behave differently in periods of stress. Adjusting exposure across these areas can help manage both income and volatility. In more uncertain environments, that may mean shifting toward higher-quality sectors or reducing exposure to areas with more spread risk.
There are also opportunities to enhance income without taking on additional duration. Bonds with call features or discounted prices can provide incremental yield while maintaining a similar interest rate profile. These decisions are not about reaching for return, but rather improving the balance between income and risk.
Periods of market stress can also create opportunities. When selling pressure increases, even high-quality bonds may trade at more attractive levels. A disciplined approach allows portfolios to take advantage of those moments while maintaining overall structure.
Building the Behavioral Firewall
Even a well-constructed portfolio can fall short if the investor cannot stay invested.
Investors need to understand what they own, how it may perform in different environments, and why it is structured the way it is. When advisors build this education into their work, it gives clients the discipline and expectations they need to stay the course when volatility rears its head.
However, these are not one-and-done conversations. We’re all only human. Even if we understand our investment plans, they need to be reinforced over time, especially when markets are moving quickly or when results diverge from expectations.
The portfolios that hold up aren't the ones that predicted every turn. They're the ones built so that when a client got scared and called, the answer was already inside the structure.
Ryan Kirk is president and head of portfolio management at NewSquare Capital.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
