Learning allocation lessons from COVID-19

Pat Noble zurich investments Bhanu Singh Dimensional Fund Advisors Stan Shamu Crestone Wealth Management Ilya Figelman Acadian Asset Management covid-19 portfolio construction constructing your portfolio

25 June 2021
| By Chris Dastoor |
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The COVID-19 pandemic was a wake-up call for asset allocation as traditional allocation strategies failed to offer downside protection as markets crashed in March.

As equities rebounded by April, conservative assets (particularly fixed income) lagged in the recovery, while equities grew quickly.

This was costly for those that switched late into fixed interest or cash and missed out on the rebound from equities.

Pat Noble, Zurich Investments senior investment strategist, said looking at the world a year after the pandemic started showed expectations could change quickly.

“But it also can show that we shouldn’t extrapolate things forever,” Noble said.

“When we saw one of the fastest bear markets in history just over 12 months ago, the tendency was to either not rebalance portfolios or allocate into a very defensive position like in cash.

“It’s hard to get out of that, but almost as fast as the market fell, we did see rapid responses from governments and central banks around the world.

“If you went into cash and you elected not to rebalance and stick to your discipline, then it’s fair to say you’ve done yourself a disservice.”

But looking forward, Bhanu Singh, Dimensional Fund Advisors head of Asia-Pacific portfolio management, said even in the post-COVID world there was not enough information to say anything was fundamentally different.

“All the parameters haven’t changed in a material way, if you ask what the equity premium is going forward, I think it’s within the historical range,” Singh said.

“What’s the bond premium going forward? Depending on how you build the portfolio that’s a bit more interesting because fixed income is pretty cool in the sense you can build different portfolios for different needs.

“For advisers, all the things they’ve done in the past are still just as applicable going forward and there isn’t anything that requires any dramatic change.”

Stan Shamu, Crestone Wealth Management senior portfolio strategist, said quality had to be the emphasis post-COVID regardless of asset class.

“Quality has to be the main differentiator of what you invest in, in this part of the market as well as being conscious and cognizant of rebalancing,” Shamu said.

“We’ve seen, particularly with equities, run fairly hard post-COVID and the temptation is to keep those positions running for a prolonged period.

“We encourage investors to remain vigilant with their rebalancing and ensuring the don’t get overexposed to any particularly asset class.

“You need to have a quality filter to avoid debt-laden companies, so if we get to the point and get to the other side and there’s less monetary and fiscal support then the business will still be around for a lot longer rather than ones that are relying on debt.”

60/40 SPLIT

The 60/40 split – 60% into equities and 40% into fixed income – had long been the basic template for a portfolio.

However, as fixed income did not offer reliable downside protection during the pandemic, the merit of the future of that strategy had been questioned.

Ilya Figelman, Acadian Asset Management senior vice president and director – multi-asset strategies, said for many investors, the 60/40 split may still be broadly suitable as a long-term static benchmark.

“However, given the very low level of current bond yields, and expectation of global reflation on the horizon, the 40% allocation to bonds may not only generate low returns, but also may not act as a diversifier to equity risk,” Figelman said.

“There are other options that may be worth considering depending on an investors particular investment requirements.”
Shamu said portfolios generally should have other options to utilise, one example being looking in the defensive alternatives space.

“[Alternatives] can work and fulfil that defensive role that bonds used to take, perhaps reducing the fixed income allocation and being more flexible with strategies that can still perform the same role,” Shamu said.

Shamu said defensive alternatives tended to have similar characteristics to bonds, particularly from a volatility and return perspective.

“That’s one main reason we’ve seen a lot of our clients focus on,” Shamu said.

“Just having a more unconstrained approach to fixed income so you can split it into other buckets that tend to give you more flexibility.”
Noble said there was always a long debate about how an asset allocation was going to perform or not perform.

“[For example] if there are high equity market valuations or if markets are a bit frothy or if your bond portfolio is not going to provide any diversification benefit and give you a return,” Noble said.

Figelman said one option was to take a more dynamic approach to asset allocation and include a broader asset class exposure.

“For example, investors may allocate to a 60/40 strategic benchmark to equities and bonds but invest with a manager that is able to incorporate exposure to other non-benchmark asset classes and then dynamically allocate across these,” Figelman said.

“From an end investors’ perspective, this may include some directional exposure to various commodities, foreign currency and maybe even volatility, but the objective would be to target return and focus risk within these asset classes at a market selection level. 

“For example, taking a long position in gold and offsetting this with a short position in silver has the potential of adding consistent active returns in excess of the 60/40 benchmark while managing directional exposure to any one asset class.

“Another option is to look for defensive alternatives investments that may take the place of government and corporate bonds given their current low yields and credit spreads.”

Singh said it was important to define what defensive assets meant within the context of a portfolio.

“If your client is a 70-year-old person in retirement and you have built up financial capital and you’re looking at your portfolio, you might come up with some allocation to equities,” Singh said.

“We think it makes sense to have some allocation to equities in retirement or building something like a 40/60 [to equities and bonds] portfolio.

“When it comes to the fixed income part of the portfolio they probably want to be fairly conservative.

“If you flip that to a 30-year-old and they’re willing to take more risk in the portfolio, they might hold an 80/20 portfolio.”

Any risk/return metric would be driven by the 80% in equities, which meant the 20% in fixed income would do little to prevent volatility, so the fixed income allocation did not need to be as conservative.

“In that scenario, models would swing the bat with that 20% with more longer-dated, more duration, more credit, to get the most return out of it,” Singh said.


Noble said advisers needed to check whether there were investments in their clients’ portfolios that could help deal with inflation risk.

“You could have inflation-linked bonds or if you don’t want that duration risk or inflation risk in your bond portfolio you might look to something shorter duration or – dare I say – even cash,” Noble said.

“You might consider where some people think there is some inflationary protection qualities in listed investments – that could be in infrastructure or commodities.

“And then there’s underlying equities investments where companies have pricing power. 

“We haven’t seen outright inflation bring problematic for a long time in markets that is potentially one of the big questions and the debate that is ongoing at the moment as to how transitory or structural these inflationary pressures may be in financial markets.”

Shamu said there had been plenty of talk around whether the recent burst in inflation was going to be sustained or was just going to be a flash in the pan.

“But it’s better to be cautious, there are different ways of getting inflation protection, the most obvious being to just get inflation insurance through some sort of inflation linked securities,” Shamu said.

“There are other levers such as real assets, particularly real estate and infrastructure, where you do get protection if inflation does rise.”

Figelman said while inflation expectations had climbed, fixed income and commodities markets had priced in largely rising but controlled inflation with some headwinds against sweeping increases in input prices. 

“Inflation is only one theme that drives markets and it is important to incorporate a wide array of themes when making investment decisions including: stimulus, growth, supply/demand and valuations,” Figelman said.

“In light of this we would caution investors to avoid reflexive and reductive inflation trades that dismiss information that we see markets efficiently pricing.” 

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