A Change in the Mood Music?
We have long championed the benefits of diversification, the Portfolios representing an orchestrated selection of differing assets and contrasting investment styles.
We make no apologies for doing so. Our mantra of Advanced Diversification has served us well over the last five years and particularly over the most recent twelve month period.
The theoretical stress testing models that our portfolios are routinely subjected to were played out for real and our rigorous investment process prepared us for what no one foresaw – both in terms of the sharp falls witnessed in March last year and the subsequent strong recovery in world markets.
Through moments of disharmony diversification works.
But What Now?
Amongst the commentariat there is speculation that traditional portfolio construction, the combination of cash, bonds and equities that has served investors so well, is outmoded and not up to the task of coping with the post-pandemic world we now contemplate.
Why invest in the US market after such a good run when the American economy and those of its trading partners have been hit so hard by the pandemic? What value can be found in bond markets when the benefits of Quantitative Easing are exhausted and any tick up in inflation or interest rates will present a more challenging outlook?
Can cash, yielding next to nothing, justify its place in a diversified portfolio?
The answers are complex but can be summarised thus: each section has its part to play and particular instruments to draw upon.
For example, the principal reason the US market has been so strong is the success, over lockdown, of the large tech stocks which now comprise around a quarter of the S&P 500 Index. While no one is doubting their long term future and the influence these companies will continue to exert, there is a recognition that valuations may be full and that regulators, both in Europe and within the Biden administration may move to limit their unbridled expansion.
That’s why some of our managers, including our own Growth Aligned funds, are investing part of their US exposure into an “equally weighted” low cost passive instrument where each company in the S&P500 index is accorded equal representation and the tech behemoths, Facebook, Apple, Amazon, Netflix, Google and Microsoft no longer dominate, collectively accounting for just over 1% of the investment. This permits our managers to invest in a vast number of much more modestly valued companies offering equally exciting prospects.
Similarly, much of the gain seen in recent years has been generated by “Growth” stocks, typically cutting edge companies offering the prospect of bigger gains in the future but paying little or no dividend now.
As we move towards a post covid environment, those more cyclical, economically sensitive, “Value” orientated companies, stalwarts with secure business models and sustainable revenue streams may take centre stage. Here again, there are low cost passive investments our managers employ to gain diversified exposure to this attractively priced corner of the market.
Within the bond element traditional securities, such as US Treasuries or UK Gilts, may still offer long term security but not the same potential returns as they have delivered hitherto. Here again, our manager partners are finding pockets of value, whether it be within Emerging Market High Yield Debt; targeting strategies that play off one country’s debt against another; or derivative instruments that actually benefit from rising interest rates.
Cash, as a long term investment, has little to recommend it. However, it remains the ultimate security against short term volatility and remains an invaluable tool for seizing the opportunities that turbulent markets inevitably expose.
As investors look for additional sources of return a fourth asset class has emerged, that of “Alternatives”.
Alternatives comprise a myriad of disparate investments ranging from gold, silver and other commodities to products based on currencies and foreign exchange strategies and ”structured products” which combine the underlying security of a bond with the inherent volatility of an equity market or other investment.
Liquid vehicles for gaining access to areas of the property market also fall under this banner and are used by some managers to diversify their investments and provide additional, uncorrelated sources of return.