Actionable insights for diversifying portfolios amid extended valuations
- Today’s market conditions risk driving investors to extremes in portfolio allocation. Duration appears to have little place in long-term strategy; extended credit is squeezing out high quality credit; the U.S. equity market struggles to earn its place in portfolios; and alternatives are moving from optional to essential roles.
- Diversification – thoughtfully conceived, carefully modulated – is especially important in an environment of extended market valuations. Our portfolio optimization framework highlights the long-term value of assets facing near-term valuation challenges.
- In time, we expect duration to return to its core protection role in portfolios. Extended credit brings greater event and tail risks. Underweighting U.S. equities has been problematic during periods of U.S. exceptionalism and strong U.S. equity performance. And alternatives present risks not encountered in traditional assets.
- Our analytic framework for optimizing portfolios supports using high quality credit in place of sovereign bonds and diversifying portfolios by adding extended credit and real assets. Within equity, emerging markets and private equity are preferred. Managing currency dynamics is key.
- Rapid market moves present a particular challenge as investors experienced the fastest-ever stock market selloff and rebound in 2020. Separating short-term price impact from long-term investment strategy will be critical for investment success.
- Governance structures need to evolve in this changing world. Investors can build deeper relationships with their partners and providers to ensure a fully integrated approach to managing risk, capturing market opportunities and accessing manager capacity and skill.
To illustrate the marginal change in portfolio efficiency, we substitute a 5% “slice” of a typical portfolio with an allocation to a single asset class
ASSET PREFERENCE BY INVESTOR BASE. RED REPRESENTS A DETRIMENT TO PORTFOLIO EFFICIENCY AND GREEN REPRESENTS AN IMPROVEMENT TO PORTFOLIO EFFICIENCY.