Asset allocators have had a tough time in 2022 during a period where equities ran out of puff and bonds lost their fluff.
As Chris Douglas, MyFiduciary principal, told the Heathcote Investment Partners ‘Meet the Managers’ roadshow last week, the go-to diversifier 60/40 portfolio suffered its worst first half-year performance in almost 50 years.
Figures cited by Douglas show an average portfolio comprising 60 per cent US shares (as measured by the US S&P500) and 40 per cent bonds (the Bloomberg US aggregate) was down more than 16 per cent over the six months to June 30 – worse even than the -6.7 per cent clocked up amid the global financial crisis peak year of 2008.
“Bonds have normally cushioned the fall in equities – in 2022 they’ve added to the pain,” he told the crowd.
But if the easy diversification option has had a difficult year, asset allocators have not responded in a uniform way to the challenges posed by the alleged ‘death’ of the 60/40 portfolio.
MyFiduciary, for example, cut exposure in its asset allocation models to bonds last year amid concerns vanilla fixed income would not provide much in the way of portfolio protection.
“In 2021 we reallocated client portfolios away from long duration assets and into cash and short-duration credit and alternatives,” Douglas said.
However, the three other researchers headlining the Heathcote show highlighted the diverse range of views among experts on how to deal with asset allocation in the ‘age of uncertainty’.
For instance, Tim Murphy, Morningstar director of Asia-Pacific manager research, pointed out that while there were “few places to hide” in 2022, investors should not allow the short-term volatility to intrude on “long-term thinking”.
“Trying to predict the inflation rate likely won’t help your clients,” Murphy said.
And bonds “aren’t dead”, he said, with some ‘unconstrained’ fixed income managers already adding duration as others mourn losses.
Murphy also touted currency exposures as a “free hedge” while imploring investors to explore multiple data sources across all asset classes before making significant portfolio changes.
“If this all seems too hard or too complex, you can outsource to an expert,” he said.
Experts agree on that at least even if they approach the subject matter from different angles.
Noah Schiltknecht, founder of NZ boutique researcher Makao Investments, for example, offered three broad hints for managing portfolio construction during volatile times – or all times, really.
Schiltknecht said investors need to account for similar exposures, use scenario analysis and “avoid biased decision-making” when building portfolios.
While his first two tips require a certain degree of technical knowledge and experience to execute well, removing in-built human biases from the investment equation might be the most difficult to implement.
Illustrating one of the several well-documented investment-related behavourial quirks, Schiltknecht presented the results of one successful derivative trading strategy that had made an annualised 75 per cent return based on 11 out of 14 correct calls in a risk-constrained portfolio.
“You’d think this must be a skilled manager,” he said. “But, in fact, it was Paul the Octopus – the same one who correctly picked the football world cup winners. There was no process and zero skill involved.”
Octopus-based portfolio management has yet to catch on (although, the species is famously intelligent) but investors are prone to similar outcome biases along with other hard-wired preferences uncovered by behavioural economists including hindsight, recency and loss-aversion biases.
“Try to account for and document these biases in your portfolio construction and management,” Schiltknecht said.
In a related vein, Michael Chamberlain, founder of investment advisory firm MCA, told the Heathcote audience that “good portfolio construction is [about] understanding the potential range of outcomes in the context of the liabilities”.
“Investment success is not about following the right predictions (guesses),” Chamberlain said. “It is about following the right principles.”
And the ‘right principles’, according to the MCA model, centre on matching investor liabilities (across short- and long-term timeframes) against portfolio exposures.
“A key to investment success, is to set the investment strategy to align with the liabilities, ie when the money will be spent, minimise fees and costs and manage the behavioural challenges,” Chamberlain said.
He said so-called “black box” portfolio optimisers can only one-off decisions about relative asset valuations.
“They can’t manage risk in the real world,” Chamberlain said.
Portfolio construction should allow for unexpected outcomes that include asking ‘what if I am wrong’, he said.
Chamberlain said advisers should focus on communicating with clients instead of trying to right portfolios with dramatic rebalancing moves during volatile times.
“But I could be wrong,” he said.