Diversification key to investment returns as the Fed tapers

After over half a decade of unconventional monetary policy against a backdrop of low economic growth and zero-bound interest rates post the global financial crisis, the United States Federal Reserve has began tapering quantitative easing.  

As this unprecedented era of ultra-loose monetary conditions ends, the PortfolioConstruction Forum Market Summit yesterday debated the risks and opportunities involved for investors and how tapering would this impact their portfolios. 

The general consensus amongst investment experts at the summit predicted an outlook of increased volatility in the financial markets, making portfolio diversification - both geographical and across asset classes - key to maintaining investment returns. 

The outlook for financial markets was one susceptible to volatility spikes and rising correlations between bonds and stocks, said Blackrock chief strategist Russ Koesterich. 

This meant finding an investment yield of 5 per cent was much more difficult today than in previous decades, with risk rising four-fold. 

The need for flexibility within an investment portfolio highlighted the importance of combining traditional and non-traditional income sources as a means of potentially lowering risk and increasing income, Koesterich said. 

Turning to diversification as a form of insurance, Koesterich said consideration of alternative investments in 2014 - such as market-neutral strategies and infrastructure investments - offered investors real portfolio diversifiers and uncorrelated returns in a low economic growth and low interest rate environment. 

“Clients need to be more comfortable with different asset classes that were not prevalent in their portfolios previously,” Koesterich said. 

The trend towards alternatives as an asset class is perhaps explained by distortions in the global financial markets from overuse of monetary policy and a breakdown in macroeconomics, according to Strategic Economic Decisions president, Dr Horace Brock. 

He said the austerity measures undertaken by western governments in the form of public sector spending cuts had seen fiscal policy no longer used as the economic stimulus it once was in previous decades.  

This lack of government spending into much-needed infrastructure projects created an opportunity for private sector investment and asset allocation towards alternatives within a well diversified investment portfolio, Brock said.