How Investors Can Approach Portfolio Volatility Heading Into 2026

Volatility is one word that has defined investment markets in 2025. April lows, driven by President Donald Trump’s tariff announcements, and the subsequent rally, combined with geopolitical uncertainty and continued artificial intelligence capital expenditure by companies and governments led to institutional investors updating their portfolios to be prepared for market volatility.

“What do you do if you build a portfolio, and then you take a step back and you look at it and say, ‘What if tariffs move up 5% or 10%? What is going to happen to my portfolio then?’” said Osman Ali, a partner in and quantitative investment strategies portfolio manager at Goldman Sachs Asset Management, in a 2026 outlook roundtable discussion. “You try to insulate the portfolio from these types of shocks, because what’s happening—and it’s actually making for more interesting active management discussions on our side—is that the role of risk management or portfolio construction is much more important now than it [had] been five or 10 years ago, because markets are so much more volatile, because markets have so many more participants.”

Diversification

Clients always seek to be as diversified as possible while structuring their portfolios to achieve investment goals and objectives, says Eileen Neil, a managing director and senior consultant at Verus. “They generally believe that diversification is the best approach through which risks are mitigated and managed. As asset allocation drives over 90% of a fund’s return and risk profile, there is not much, if any, meaningful benefit to be gained through individual investment strategies such as defensive equities.”

Neil notes that actively managed strategies can benefit asset classes where some of the inherent risks are difficult to predict or assess: “The emerging markets benchmarks are a good example. In these markets, active managers can add value by maintaining smaller exposures in countries with high geopolitical risks. Thus, active management can be an effective approach to risk management in some markets.”

The largest contributor to overall portfolio risk for most institutional investors is equity risk, Neil says.

“Thus, clients that wish to mitigate their equity risk exposure typically do so through diversified portfolios, which include at least fixed income, which can be an effective risk mitigation approach, particularly if the strategy is very high quality or all Treasurys,” Neil says. “Some clients also employ low-equity beta [and] correlation absolute-return strategies, such as [commodity trading advisory strategies], in addition to fixed income as a means to somewhat mitigate equity risk.”

Institutional investors should resist the urge to react to each bout of volatility or try to forecast its source, says Sutanto Widjaja, the CIO of Farther Institutional, a financial adviser to endowments, foundations and other organizations. “Managing volatility well is about correct position sizing, rigorous manager selection and maintaining allocations to diversifiers such as hedge funds or government bonds that are intentionally designed to offset risk assets during periods of stress.”

Heavy index concentration in large technology companies has also led to an increased interest in actively managed strategies, says Yung-Shin Kung, CIO of Mast Investments.

“The concentration of equity benchmarks, such as the S&P 500, has dramatically increased the riskiness of passive investing,” Kung says. “We believe that investors will continue to look toward active approaches to exploit the current business cycle and to manage market volatility.”

Many institutional investors note that traditional diversification of stocks and bonds may be insufficient in today’s environment of correlated risks, according to Erika Olson, director of public markets manager research at Meketa Investments.

In response, the consultant seeks to build multi-layered risk mitigating frameworks that can enhance resilience across different market regimes. “These frameworks typically segment strategies into functional roles; First Responders such as long-duration Treasuries, long volatility, and tail-risk hedges for sharp high volatility drawdowns; Second Responders like systematic trend-following to capture persistent extended drawdowns; and Diversifiers such as global macro and alternative risk premia, among others to provide low correlation and positive returns over full cycles,” Olson says.

Volatility Outlook

As the equity markets finish off what could be the third year of a bull-market rally, investors are cautious about positioning for 2026. A report from Northern Trust Asset Management projected elevated valuations and episodic volatility to continue next year. The manager recommended that investors have exposures to quality and value stocks, as well as to low-volatility factors.

The AI boom shows no signs of slowing, despite surging valuations and questions about whether AI companies can justify the trillions of dollars that will be spent over the next decade.

Rupert Watson, global head of economics and dynamic asset allocation at Mercer, noted in a recent report that spending on AI will continue to be at the forefront of economic activity, while the tariff-driven trade war will likely fade into the background.

“The thing with volatility is that it is painful, but it is also one of the mechanisms by which you can outperform,” says Bill Hench, head of the small-cap team and a portfolio manager at First Eagle Investments. “People who play it straight down the road and don’t take any chances or risk are going to have less volatility, but they’re also capping their performance. … To the extent that you take advantage of that volatility, you should be able to enhance your returns. It’s a matter of what your client’s appetite is for that volatility.”