V, W, square-root — no, the recovery will look more like crocodile teeth as markets start to normalise away from the easy investing environment of the past 20 years, said Canonbury Group president Dr Philippa Malmgren.
And when it comes to asset allocation, the happy days of ‘set and forget’ are over.
Speaking at the PortfolioConstruction Conference in Sydney yesterday, Malmgren brought the audience back to earth when she said: “I don’t want to argue for a new paradigm — I do want to argue that we are going back to the old paradigm.”
In considering how the global financial crisis has changed asset allocation, she said the industry needed to rethink volatility. She said the past 20 years saw volatility continue on a downward trend.
“Overall, people became accustomed to an ever easier investing environment,” Malmgren said. “And this has now reversed. History will say that that period was a very nice aberration, but it was an aberration. Normal investing environments do involve volatility, they do involve statistically unlikely events, and they do involve the need to pay a lot more attention to the risks of a portfolio that you cannot quantify.”
She said over the past 20 years, the financial services industry had become increasingly comfortable with the idea of ‘set and forget’.
“I think in the new world, which as I’ve said will be a restoration of a more normal investment environment, it’s all about ‘anticipate and recalibrate’,” Malmgren said.
“You are going to have to anticipate where you think risk is going to travel in this new environment.”
Malmgren said that things cannot return to the happy days of the past 20 years because debt is such a huge issue that government policy and the interests of citizens come into play. In this environment, she said, governments have four options — accept deflation, default, devalue and inflation.
She said inflation is interestingly one of the principal topics recently discussed by US policy makers.
“What is the policy mix of those four choices that the government is going to choose, because what will happen is that the market is going to arbitrage between the different outcomes,” she said. “If inflation turns out to be the logical and only choice for a number of governments, that obviously has a huge impact on portfolios. This is a profoundly different kind of investment environment than what we had before, when we had universally low inflation, lots of downward pressures on inflation, and low volatility.”
She said in choosing between the four options, and then having a market arbitrage between different choices, “this is telling me that we are going to have a higher amplitude of volatility across most asset classes”.
In discussing inflation and deflation, Malmgren said that rather than a V or W-shaped recovery, it would be a saw-tooth.
“It’s like a crocodile that will chew on your portfolio. Coming out of a slowdown is a very difficult period, and we’re going to get buffeted about by inflation and deflation, appearing on our radar simultaneously,” she said.
