The situations in China and Greece, not to mention Puerto Rico’s debt woes, serve as a poignant reminder not to be complacent. Investors should take care that portfolios are well constructed, diversified, and consistent with their ability to absorb downside risks while meeting long-term return objectives. With risks rising in some areas, and few bargains to be had, better investment opportunities may lie ahead. In this environment, investors should remain neutral on risky assets as a whole, tilt to what’s relatively cheap, remain cautious and selective where assets are expensive, but not take significant bets relative to policy or neutral positions. Now is the time to identify how you are going to take advantage of such opportunities when they eventually arrive.

Investors’ faith in central banks and policymakers is being tested. Markets have obediently appreciated when monetary policy is loosened and punished when it is tightened, at least in relative terms. Markets have also accepted that Beijing has an arsenal of resources to manage a rebalancing of its economy and to handle any repercussions from China’s rapid escalation in debt as a share of GDP. That cycle is showing its first signs of breaking as easing measures in China combined with aggressive policies to encourage equity purchases failed to achieve an immediate response from Chinese equities. At the same time, the world may get to see whether the European Central Bank (ECB) does have “whatever it takes” to contain the risks associated with a Greek default and possible (though unlikely) exit from the Eurozone.

A bailout agreement appears within reach for Greece, and the consensus is that the ECB has the ability to contain any near-term risks associated with a Greek debt default and potential “Grexit.” The ECB certainly has more tools at its disposal today than it did in 2012, when Europe last confronted the prospect of a Greek default and exit. However, even if Greece remains in the Eurozone, the mere suggestion that a country could be temporarily pushed out of the euro—raised in the negotiations this weekend—could mean markets start to price in a risk premium in peripheral sovereign debt, increasing the cost of capital for peripheral European and corporate borrowers, slowing economic activity, and increasing debt burdens. While the ECB has the ability to push rates down, it would be important to convince the markets that Greece is a special case and that exit from the euro is not possible for other countries. We remain constructive on Eurozone equities given improving economic growth, signs of improving earnings, and potential for increased dividends and buybacks. Political risk should not be ignored, but many technical and fundamental factors support an overweight to Eurozone equities relative to overvalued US equities. We would view a material decline in Eurozone equities as an opportunity to increase positions at more favorable valuations.

China remains a double-edged sword for investors. Monetary easing in China has both helped reduce the risk of a near-term hard landing and ignited the massive rally in the onshore A-share market that has now, predictably, turned into a rout. We have been wary of chasing the A-share rally, given high valuations and a ramp-up in margin lending, and believe Hong Kong–listed Chinese equities offer more reasonable value. The A-share market will likely remain under pressure and range bound as retail investors reduce their margin exposure by selling into rallies, thus capping market upside. The ultimate question for Chinese equities (both onshore and offshore) is the degree to which earnings growth is improving. If the decline in equities feeds back into the economy, it could cause a setback in earnings growth; evidence on earnings improvement and linkages between equities and the economy are mixed. We prefer to have exposure via Hong Kong–listed equities given less downside, lack of leveraged investors, and cheap valuations that provide some margin of safety. Investors that have taken our advice and implemented an overweight to Asia ex Japan or emerging Asia relative to US equities already have an overweight in Chinese H-shares.

Events in China, Greece, and Puerto Rico should serve to remind investors of the importance of a well-diversified portfolio that includes diversifying hedge funds outside of the real assets space with less equity and credit exposure, as well as some high-quality sovereign bonds. We continue to advocate holding some portion of portfolios in high-quality sovereign bonds, even at low yields. We also advocate that investors—other than those seeking to defease liabilities (e.g., pensions)—hold a portion of sovereign bond portfolios in cash. Low yields mean low expected returns and limited capacity for appreciation in the event of a risk-off environment. We expect bond volatility to persist as markets evaluate future growth prospects for the Eurozone, potential for the US Federal Reserve to raise the Fed Funds rate, and risks associated with slowing Chinese economic growth. This may provide an opportunity to move cash back into sovereign bonds at more attractive valuations. We also continue to be concerned about the potential for limited liquidity in corporate bonds, particularly given the liquidity mismatch relative to the daily liquidity on offer by exchange-traded funds and mutual funds.

Making sure that portfolios are aligned with risk tolerance and return objectives is critical in allowing asset owners to withstand volatility and to take advantage of opportunities that may arise.

Celia Dallas is Cambridge Associates’ Chief Investment Strategist.