“Embrace the Chaos.”
(Quote attributed to Friedrich Nietzche, famous 19th century German philosopher)
By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner
Reviewed by Carter Mecham, CMA®, IACCP®
The term “VUCA” has been around since the 1980s and was introduced by management and leadership experts Warren Bennis and Burt Nanus in their book “Leadership: The Strategies for Taking Charge”.[1]
The initial application was for the US Army as it recognized the need to change its approach to defensive readiness in the wake of the fall of the Berlin Wall. The belief was that this would usher in an increasingly chaotic geopolitical world, and the Army needed to adapt and adjust accordingly.
So, what does VUCA stand for and, in the context of investing and portfolio management, what does it suggest?
Returning to a VUCA World
The term VUCA stands for:
- Volatility: The concept that change is no longer gradual – it can be sudden and explosive. We certainly witness this on a regular basis in the global capital markets.
- Uncertainty: Traditional forecasting is proving to be increasingly unreliable. We operate in increasingly unpredictable global markets, not to mention national and geopolitical tensions.
- Complexity: Historically simple relationships seem to be fading away, and we increasingly operate in a market of complex interdependence and continual innovation. One needs to look no further to see this than the application of artificial intelligence to investment management (still in its early days, but with exponential growth expectations).
- Ambiguity: It seems that in the investing world, very few things are black and white anymore – we live in a world of gray where clear answers often don’t exist.
Source: “Entrepreneurial Mindset in the VUCA World” by Merve Erbeck, 2022.
For most of the past ten years, many investors lived in a very “un-VUCA” world – interest rates were low, equity market volatility was almost non-existent, and investing seemed fairly simple – just “buy the index and ride the beta wave.”
Anyone who deviated from this approach was often accused of “deworsifying” their portfolios. It often appeared that traditional portfolio management approaches – asset allocation, diversification, portfolio optimization, and so forth – were no longer applicable and “this time it was different.”
But that expression has proven to never be true. Fundamental investment principles exist for a reason – because historically they work over any reasonable time horizon.
We believe we are entering a new (or returning to an old) market regime, with increased volatility and uncertainty. In addition to increasing geo-political tensions, here in the US we have increased uncertainty over taxes, tariffs, the direction of the economy and inflation, Fed policy and, in fact, the functioning and operations of the Fed itself.
In this evolving environment, we believe fundamental investment principles will once again matter. If we are correct, how might we respond to what may be an increasingly “VUCA-like” market?
Using Positive VUCA in Portfolio Construction
I was fortunate last summer to be invited to speak and participate in the annual Portfolio Construction Forum down in Australia, sponsored by the CIMA® Society of Asia Pacific. It was both a fascinating and informative event.
During that event, I was introduced to a potential investment response to a VUCA market environment – let’s call it “Positive VUCA”:
- Vision: The ability to see the market environment clearly, based on facts and not clouded by biases or pre-judgment.
- Understanding: Being aware of and informed about the choices and options that are available to us to meet current market environments and specific client needs and objectives.
- Clarity: Having a clear, consistent, and defensible investment philosophy and portfolio construction approach.
- Agility or Adaptability: The ability to pivot or evolve as market conditions change, without losing sight of our core investment philosophy.
Source: Dreamstime.com
How might we translate “Positive VUCA” into a portfolio construction philosophy?
Let’s begin by reminding ourselves of something we wrote about in a recent blog[2] – the concept of “economic regime investing” and building “all-weather” portfolios.
The phrase “all-weather” refers to building portfolios that generate consistent performance regardless of the underlying economic and market regimes.
The simple schematic below illustrates the four primary phases of the economic cycle, based on whether the economy and inflation are increasing or decreasing.
We can then overlay this schematic with which types of investment strategies have the potential to perform best during which phase of the economic cycle.
Definitions: “Capital Growth” = Equity strategies, “Income” = Rate and Credit strategies, “Real Assets” = commodities, precious metals, real estate, infrastructure, MLPs, etc., “Volatility Management” = alternative and private investment strategies. For illustration purposes only – does not represent investment advice.
We believe this is an appropriate “Positive VUCA” response to an increasingly VUCA-like market environment.
This is nothing new. In fact, it represents somewhat of a “back to the future” approach. It suggests that constructing Defensible, Understandable, Resilient, and Flexible portfolios is a logical way to manage and mitigate VUCA.
[Might we call this a “DURF” portfolio? No, we won’t – it doesn’t have the same catchiness as VUCA, does it? Anyway…]
Put differently, this Positive VUCA portfolio would be characterized by:
- Global diversification across traditional long-only asset classes (stocks, bonds, and real assets)
- A reasonable time horizon (5-7 years)
- The intelligent allocation to both active and passive investment strategies, to optimize fees and taxes, and
- The prudent use of both alternative and private market investments to potentially achieve better diversification and higher risk-adjusted return.
Most threats to any system, environment, or market offer equal and opposite opportunities.
In this case, the potential threat is characterized by what we believe will be a market of increased volatility, uncertainty, complexity, and ambiguity.
The opportunity is that this seems to be an ideal time to get in front of investors and explain to them why this “Positive VUCA” investment approach makes sense – it has vision, understanding, clarity, and adaptability.
This “all-weather” approach, we believe, represents the best opportunity to deliver consistent performance over time, regardless of market regime.
As always, we welcome your questions and feedback.
[1] Leaders The Strategies for Taking Charge: Warren Bennis & Burt Nanus: 9780060913366: Amazon.com: Books
[2] “The Role of Alternative and Private Market Investments in Diversified Portfolios”, January 2025.