Portfolio Strategies: Some new tools in the toolbox
Rising volatility and changing market conditions where previously uncorrelated assets now move in sync suggests that investors need to be more cognisant of risk within portfolios and integrate dynamic and sophisticated risk analytics into investment process and decision-making. Another approach would be to consider using a risk-factors based approach to portfolio construction. Northern Trust AM proposes combining macroeconomic factors into a single risk factor model that can assist in developing portfolios that are truly diversified across asset classes and market states. Risk Parity strategies and an allocation to defensive equities are also ways in which investors can mitigate some of the more extreme bouts of market volatility, while portfolio rebalancing, if executed correctly, during market turbulence can be seen to add alpha, while also minimising tracking error.
Northern Trust AM argues that investors should consider using a risk factors-based approach to portfolio construction, as traditional asset class diversification may not offer optimal results, particularly during times of market stress.
In this paper from PGIM Quantitative Solutions, they propose that investors consider the use of appropriate risk platforms flexible enough to cope with increased market volatility and asset correlations. Ideally, such a platform should be able to incorporate ‘what-if’ scenarios and facilitate portfolio stress testing.
For compliance reasons, this paper is only accessible in certain geographies
Intech's paper argues that defensive equities perform better than expected across a variety of market conditions. They do exhibit characteristics of a cyclical asset class, but getting the timing correct as a tactical asset class is notoriously difficult. Consequently, Intech suggests they should be considered more strategically, to provide diversification benefits for equity allocations.
Robeco notes that emerging markets look undervalued at present. They examine the reasons behind this and discuss both the risks and opportunities.
Man Group examines what has been changing across the equity landscape in recent years, noting that passive investing now accounts for around 30% of the market, driven mainly by dimunition in active manager share. Other significant points to note are the rising significance of ESG investing and the decline in market share of Value investors.
This paper discusses the move away from the traditional 60/40 model portfolio in the 1980s towards the Endowment Model, popularised by David Swensen of Yale, which allocated towards higher risk, higher return assets such as private equity and hedge funds, which have provided superior absolute and risk-adjusted performance over the more traditional approaches.
Parametric argues that periods of market volatility offer investors the potential to add value through portfolio rebalancing though it can be challenging. Done correctly however, with proper controls and monitoring, it can result in added alpha and improved portfolio tracking.
The authors examine a quantitative method that measures turbulence in trend following, one of the more popular dynamic investment strategies.
Risk Parity is a popular approach to portfolio diversification, and in this paper S&P Dow Jones Indices outlines the returns their Risk Parity Indices produced in Q1 2022 and the asset allocations which contributed to superior performance.
For compliance reasons, this paper is only accessible in the EMEA region
For many portfolios, the equity allocation is one of the key drivers of performance. Franklin Templeton puts forward that concentrated equity portfolios outperform benchmarks, passive funds, and highly diversified funds. Despite the lower number of stocks held, a high-conviction, concentrated portfolio can be constructed where the individual holdings offer uncorrelated risk.