A smarter portfolio to mitigate shocks in a less predictable world

Diversifiers are investments meant to help achieve more robust outcomes. Stocks, broadly speaking, struggle when economic growth contracts, so we diversify with bonds, which tend to do well when growth weakens.

Fixed income remains an indispensable portfolio diversifier, yet it has proved less successful against bouts of inflation, recent and past. There is more than one kind of shock in financial markets, as investors were reminded recently. The expanded diversification toolkit aims to help insulate portfolios from a range of different shocks.

Indeed, as 2024 LTCMA forecasts call for ongoing, elevated macroeconomic uncertainty, finding additional sources of risk diversification may be as important as finding sources of return.

We propose such dimensions of diversification to create enhanced balanced portfolios, identifying a basket of further diversifiers to broaden out and complement a standard 60/40 stock-bond portfolio for a wider range of environments. The basket includes:

  • Actively managed equity
  • Tactical asset allocation strategies
  • Risk premia strategies
  • Currency overlays
  • Thematic investing
  • Alternative assets - particularly real assets, hedge funds and private credit, which exhibit low correlation to traditional assets and the opportunity for downside resilience, enhanced returns and inflation protection

We identify these diversifiers by drawing on historical evidence; the knowledge that they each shine in different economic environments; and by running simulations using our robust asset allocation model to capture the effects of different possible regimes.

Testing a portfolio incorporating the full range of these potential diversifiers, we examine their performance in aggregate and provide an example of the new, smarter, more robust balanced portfolio. 

The smarter portfolio provided a smoother ride in our simulations – especially helpful because its value comes when it is most needed. Long-term wealth creation is not only about generating more return but also avoiding wealth destruction.

The diversifiers in our basket have historically delivered positive returns, are not costly (like traditional portfolio hedges) and are fairly valued. Those qualities make the present moment a timely one for reshaping portfolios by expanding the diversification toolkit.