Diversifying among asset classes without proper forecast performance expectations is simply diversifying losses, rather than avoiding them, Mason Stevens’ fixed income investment strategist Jesse Imer said.
According to him, the most important factor at the moment was that investors stayed truly diversified but also they needed to be tactical in their asset allocation.
This meant that currently investors needed to focus on non-correlated assets or trading strategies with investment managers that had mandates to achieve investors’ goals, Imer stressed.
“We’re entering a period of moderation with potentially lower returns in equities based on existing developed market valuations, but also of limited capital upside for bonds as interest rates are near the zero-lower bound,” he said.
Imer also reminded that Markowitz’ original Modern Portfolio Theory explained that the concepts were not meant to be confined to stock and bond portfolios only, but that Modern Portfolio Theory should be an ever-present mindset and that portfolio managers should remain vigilant to uncompensated risks from inherent correlations between similar investments.
He said that people read it that they needed to diversify stock portfolios with fixed income for the volatility smoothing effects but missed the overarching message that portfolio managers needed to manage risk to achieve forecasted returns.
Also, investors often did not have expected returns front of mind for markets while each incremental loss required a slightly larger gain to return to breakeven. For example, a 40% loss would require a subsequent 67% rebound/gain to breakeven and, likewise, a 50% loss a 100% rebound, or an 80% loss a 400% rebounded.
“Therefore, we must remember that we need to build genuinely diversified portfolios, then review them periodically as their past performance and diversification may not be suitable as financial markets evolve,” Imer said.