{"id":45268,"date":"2015-10-01T02:19:53","date_gmt":"2015-10-01T00:19:53","guid":{"rendered":"http:\/\/beta.next-finance.net\/strategie\/is-traditional-asset-allocation-no-longer-an-option\/"},"modified":"2015-10-01T02:19:53","modified_gmt":"2015-10-01T00:19:53","slug":"is-traditional-asset-allocation-no-longer-an-option","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/strategie\/is-traditional-asset-allocation-no-longer-an-option\/","title":{"rendered":"Is traditional asset allocation no longer an option?"},"content":{"rendered":"

Sometimes, I wonder if asset allocators realise how lucky they used to be.<\/p>\n

We used to have the luxury of combining bonds with equities to form a diversified
\nportfolio. Sovereign bonds \u2013 from many countries \u2013 used to be of high quality. But
\nI am afraid that those times are now over. Why? Because quantitative easing has
\ndestroyed the very properties of fixed income that made the asset class an essential
\npart of a balanced allocation. Factor investing may be the best solution we have.<\/strong> <\/em><\/p>\n

<\/p>\n

For most European investors, domestic sovereign bonds form the basis of their asset
\nallocation. These bonds used to provide an attractive yield as well as strong diversification
\nbenefits. But what do we actually mean by diversification? For me, it means they could be
\nrelied upon to protect an investor\u2019s assets in times when it really mattered: good sovereign
\nbonds normally rose in value when the equity markets were falling. What\u2019s more, the
\ncoupons they provided would in many cases account for most of an investor\u2019s expected
\nreturns, and sometimes their projected liabilities, on their own. This now seems like
\nsomething of a dream. <\/p>\n

What other asset classes can investors look to for diversification? Real estate is an
\nobvious example, but its poor liquidity is a major drawback. Institutional investors tend to
\nhave mixed feelings about commodities, as they are attracted by their (sometimes) low
\ncorrelations but put off by their high levels of volatility. Hedge funds, for their part, seemed
\nto be the miracle cure around 2000 but \u2013 and this only applies to the better ones \u2013 they
\nare at best interesting satellite solutions. Strangely, the fees they charge have been more
\nof a concern to investors than their correlation to the equity markets.<\/p>\n

The problem is quite simple. Investors want to be able to replicate the past behaviour of sovereign bonds, but in today\u2019s world that\u2019s just impossible. Sovereign bonds used to be of the highest quality, providing excellent diversification benefits as well as an attractive coupon.<\/p><\/blockquote>\n

Now, they are no longer safe (as we saw in the Greek debt crisis) and, without a yield, they may have lost their ability to provide diversification (unless we imagine a world of prolonged significant negative interest rates). Worse still, we can envisage scenarios in
\nwhich rates move higher while the stock markets fall. And what will be the long-term
\nrationale for investing in bonds that do not provide a yield? Counterparty diversification
\ncannot justify the high probability of investors losing their money after the effects of
\ninflation. <\/p>\n

<\/p>\n

The natural thing for investors to do in recent years has been to seek diversification by
\nallocating to asset classes that resemble sovereign bonds: these include convertible
\nbonds, high yield, emerging market fixed income and private debt to name a few. But a
\nmajor problem with these strategies is that they behave more like equities than sovereign
\nbonds. <\/p>\n

Through a combination of the falling quality of sovereign bonds and the forced
\ndiversification of their fixed income bucket, investors have made their fixed income allocation more equity-like. This is far from reassuring! It\u2019s probably the exact opposite of
\ntrue diversification.<\/quote><\/p>\n

Alternatives, meanwhile, are a fantastic concept, but quantitative easing has killed off
\nvolatility and, in the process, most long-volatility strategies. This has led investors to
\nfavour equity-related strategies instead. What\u2019s more, the hedge fund space has become
\nextremely blurred between areas such as liquid and illiquid absolute return, total return,
\nunconstrained fixed income and more. <\/p>\n

At the same time, equities have become more complex. The ultra-low-yield environment
\nand the search for return has resulted in some parts of the equity universe becoming a
\nsubstitute for fixed income, and more likely to react negatively if rates increase sharply.
\nIn short, equities are becoming more like fixed income, and fixed income like equities.<\/p>\n

<\/p>\n

So to summarise, we still use an old asset allocation system that has worked well overall
\nfor a number of decades \u2013 even though the returns of equities were hard to predict, fixed
\nincome returns were relatively easy to forecast over longer timeframes. But now, the
\ningredients of a traditional balanced portfolio have changed massively in nature. Against
\nthis new backdrop, what are our chances of future success? <\/p>\n

First, we have to understand that for the moment we can no longer count on fixed income
\nto create diversification in our investments.<\/quote>
\n If one of the two main motors of portfolio
\nperformance is off for now, the only one still working is the equity beta motor. We can all
\nconceive the effects of a world in which sovereign bonds don\u2019t provide the security that
\nthey used to. In such a scenario, we would have to sharply increase the speed at which we
\nadd and remove risk to and from portfolios as the safety jackets we used to have on board
\nno longer work. We would also need to make more tactical allocation moves.
\nSecond, we
\nwould have to expand our investment universe to improve diversification and seek
\nadditional sources of return.<\/quote><\/p>\n

<\/p>\n

So what do we as asset allocators have at our disposal in our armoury today? Not much,
\nother than factors. Factors are quite similar to asset classes in the sense that they both
\nrequire a risk premium, but factors are more straightforward to deal with \u2013 they are a pure
\nmathematical measure.
\nFactors don\u2019t care if the data series relates to convertible bonds or
\nequities; they will spot the moving force behind the series.<\/quote>
\n The bad news is that client
\nconstraints, regulation and investment processes will have to evolve for us to be able to
\nuse them in place of the old system combining bonds and stocks. I hope this will happen
\nquickly enough that we don\u2019t have to wait until major issues arise in traditional asset
\nallocation, forcing us to recognise that there is a problem. <\/p>\n

Factors are not a panacea. Their relationships are not stable over time and their definitions
\nare still to be standardised, but they provide us with a useful level of diversification.<\/quote><\/p>\n

This is the case for the standard factors such as capitalisation size, quality, dividends and
\ncountry, as well as the more alternative ones such as momentum and carry.<\/p>\n

Factor investing is not a cheap option, but it represents a fascinating new dimension in
\nhow to measure and respond to risks.<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Sometimes, I wonder if asset allocators realise how lucky they used to be.
\nWe used to have the luxury of combining bonds with equities to form a diversified portfolio. Sovereign bonds \u2013 from many countries \u2013 used to be of high quality. But I am afraid that those times are now over…<\/p>\n","protected":false},"author":1,"featured_media":45266,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1483],"tags":[1809,1655,1657,1651,1807,2087,2068,2118,1901],"_links":{"self":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/45268"}],"collection":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/comments?post=45268"}],"version-history":[{"count":0,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/posts\/45268\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media\/45266"}],"wp:attachment":[{"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/media?parent=45268"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/categories?post=45268"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/beta.next-finance.net\/en\/wp-json\/wp\/v2\/tags?post=45268"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}