As factor and multi-factor investing become more commonly understood investment styles, different strategies can help mitigate specific risks in choppier markets.

“Nobody wants to hear about risk until it’s too late,” said Carlos Phillips, vice-president and director at TD Asset Management Inc., at an event hosted by the firm in Toronto on Tuesday.

A significant increase in volatility during 2018 should serve as a healthy reminder of the fragilities investors might have in their current positioning, said Phillips, noting that warning should be prompting investors to look more closely at how they’ll protect themselves against the next major downturn. In using factors, strategies can get a lot more granular when attempting to address certain types of risk.

Two specific volatility spikes in 2018 told very different stories, said Phillips. Earlier in the year, there was a jump relating to inflation worries. “Wages went up much higher than people expected. That sent your equities and your fixed income tumbling at the same time.”

Later in the year, markets received signals from the U.S. Federal Reserve, which they broadly interpreted as more rate hikes coming down the pike. “That led to a fear the central bank might trigger the next recession. That’s a growth scare.”

What’s notable about these volatility spikes is they were triggered by relatively minor economic factors, he said. While there were shifts in inflation and growth, they weren’t major changes to the market environment. “What do we learn from this? We’re learning small amounts of information, a small event, is enough to trigger significant turmoil in markets today.”

In this reality, investors can look at how capturing different factors mitigates different types of complex risk, said Phillips.

Factors’ upside and downside capture demonstrate how each one protects a portfolio when markets are in trouble, but also where it provides alpha, he noted, adding low volatility and quality strategies are all about generating value when the market is tumbling. Value, momentum and small-cap strategies, on the other hand, can help increase the pay off when markets are rising.

While these factors generally behave this way, not every market drop or rally is the same, said Phillips.

The two risks experienced in 2018 — one based on inflation and one on growth — can be used to demonstrate how different factor styles respond to distinct types of downturns, he noted. “We have a lot of data, a lot of information, about these kinds of scenarios.”

In capturing that data, Phillips demonstrated how different factor strategies perform when there’s any hint of inflation, rather than isolating major inflationary events. “In those scenarios, we see a different profile. Styles don’t behave the way you expect.”

Here, small cap provides investors with less on the upside than it loses on the downside, whereas the value strategy is outstanding in this environment because its upside potential beats the market in an inflationary environment, as well as the growth environment, where it is more commonly expected to, he said.