The End For The Traditional Portfolio???


The End For The Traditional Portfolio???

Could this be the end for portfolios as we know them?

April 21, 2022

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This week's midweek commentary is titled:

'The End For The Traditional Portfolio?’

Your traditional  IFA/wealth manager model will have been tripped up by the obvious, and there’s nothing they can, or will do about it.

Pensions could be even worse hit.

So what is a traditional, ‘diversified portfolio’?

For arguments sake, let’s take what IFA’s would consider to be a mid-risk level portfolio. This is likely to have about 60% equities, 25% bonds, 10% government bonds, 5% gold and alternative assets.

This varies of course, but it won’t be far from accurate and will be referred to hereafter as the 60/40 model. 60% equities, 40% bonds/defensive.

Historically this has been a solid model and is now the one followed by pretty much all IFA’s across the UK. Funds are allocated, and left to their own devices so that the managers can get back to looking for more money.

However, this model has come unstuck as there is a glaring and obvious flaw that has been looming round the corner for the past few years and is only now coming to fruition.

Most wealth managers won’t have seen it coming, and even if they did, there isn’t a lot they can or will do about it. As we’ve stated many times, most IFA’s have one goal and that’s to bring in more money. They are salesmen first, money managers second.

So what is the problem?

Tapering coinciding with interest rate rises. Only one result, falling bonds, falling gold, falling assets, regardless of what they are.

Once quantitative easing was introduced, central banks started buying massive quantities of bonds. This meant holders of bonds who could sell out, such as investment banks, did just that. They subsequently bought anything and everything else. The result was a rallying bond market, a rallying equity market, a rallying gold market – to be honest, everything rallied.

Your fund manager/wealth manager/IFA or whatever you may have, will not have been able to sell due to the 60/40 model they are practically obliged to stick to. The value of your holdings might have gone up, and now they will go down.

Their equity holdings and their bond holdings will have made money over the last couple of years, but if you don’t sell, it is only ever money on paper and no profit will have been taken.

Now comes the consequence of inaction.

Once central banks started even talking about tapering, only one thing was going to happen.

As we have said, bond prices historically increase as equities decrease in a traditional ‘risk on, risk off’ approach, this is why it is considered a ‘hedge’. Gold also tends to be a hedge against the 60% equity portfolio as it rallies in times of trouble.

Tapering refers to unwinding the massive purchases of government bonds and mortgage-backed securities central banks have been making to shore up the economy during the pandemic.

The unconventional monetary policy of buying assets is known as quantitative easing.

By adding money to the system, they were able to keep the financial system ticking over and avoid panic.

The main consequence of this is that bond prices, and in particular government bond prices, are incredibly high. This pushed yields very low, meaning there was no point in buying them – however, your pension and your IFA have to buy them due to the 60/40 model.

Anyone who bought a government bond over the last couple of years has been paying the wrong price. We’ve pointed out in many articles that some government bonds were even negative yielding: this literally means if you’d bought one, and held it till the end of its time, you are 100% guaranteed to lose money.

Sadly, the fact is, many of your portfolios will have still bought them as managers refuse to adapt and ignore the old fashioned model.

We found this very strange, yet it has become almost normal and funds just kept buying.

If it sounds like a bad investment, it probably is, and you can’t get much worse than a guaranteed loss in our game, but the herd mentality will always prevail as it is the easiest and laziest course of action.

BUT just because everyone is doing it, doesn’t make it right. When something that is clearly wrong, gets accepted as right, run for the hills.

Now that tapering has begun, fund managers have been tripped up as global stocks and bonds have fallen in tandem in the first quarter.

The FTSE All World stocks index, including dividends, dropped 5.1 per cent in the first three months of the year, reflecting rising benchmark interest rates and the outbreak of war in Ukraine. At the same time, soaring inflation and tighter monetary policy took 6 per cent out of the hedge against falling stocks according to the Bloomberg Global Aggregate Bond index,

This left those holding relatively low risk investments, with a ‘diversified portfolio’ in which everything fell.

The two key markets underpinning global finance are seldom correlated and such moves tend to be rare and brief. This year’s quarterly slump — the worst synchronised decline since both benchmarks have been available — is enduring enough to leave investors questioning how to balance risks in their portfolios.

The problem we see, is that there is no reason for this to change in the short term. So much money was pumped into the system that bonds could just keep going - the US alone added $9 trillion onto the FED’s balance sheet. This is 4 times the value of the entire FTSE 100.

Bonds are a low performing, low risk investment; dropping 6% in the first 3 months of the year is more like the move of a high risk asset, not a low risk one. This move could potentially have taken out 2 years of fixed income interest from your portfolio.

“The first quarter was challenging,” said Seth Bernstein, chief executive of $779bn US asset manager AllianceBernstein. “There was nowhere to hide for investors.” For years, a 60/40 balanced approach has been the mainstay of investment portfolios, where investors allocate 60 per cent to equities, for capital appreciation, and 40 per cent to bonds, to potentially offer income and risk mitigation.

This worked well over the past decades….but this model now faces some serious strain. “Conventional portfolios are in big trouble,” said Duncan MacInnes, an investment director at £25.3bn wealth manager Ruffer.

These kinds of returns from a ‘balanced portfolio’ do not look sustainable over the next decade. US stocks are high and bonds are up against the challenges of ultra-low yields, inflation and the prospect of a cycle of rising interest rates.

Michael Hartnett, chief investment strategist at Bank of America, said rising inflation rates meant a third “great bear” market for US bonds was now under way.

The war in Ukraine has heightened these pressures by pushing inflation still higher and compromising the growth outlook. “From a purely economic point of view, Russia/Ukraine has exacerbated what was already an incredibly difficult position for policymakers,” said Ruffer’s MacInnes.

In this environment, fund managers are advising clients to diversify their investment portfolios — and temper their return expectations, but that isn’t a lot of help when all assets are high.

Even diversifying into gold won’t help as that too is at an all-time high. The search for returns has inflated every market there is.

Vanguard’s LifeStrategy Moderate Growth fund, which follows the 60/40 model has delivered a total return, after fees, of 9.1 per cent over the decade to December 2021. A return that many will be familiar with, and may even have started to count on.

Vanguard has now cautioned that returns over the next decade for a 60/40 balanced portfolio are expected to be half that — even before inflation is taken into account. For such a big name to essentially be telling clients that they are unlikely to do much better than a 3%  return over the next 10 years is just embarrassing.

“A core problem for investors is that 60/40 doesn’t look like it has much return potential,” says Peter Van Dooijeweert, head of multi asset solutions at $148.6bn asset manager Man Group,.

However, he cautioned that “it’s easy to say that you need to diversify but it’s not that easy to implement, especially as asset classes like commodities have had monster moves up and no one has forgotten crude was at negative prices only two years ago.”  

“If you look at everything that was thrown at markets in the first quarter, this feels like an OK outcome,” said Man Group’s Van Dooijeweert. “You had a major war, a huge commodities shock, a very hawkish shift in central bank policy, China markets collapsed and then rebounded and the nickel market closed. With all of that noise in the markets I don’t think we’re doing that badly. It could be a whole lot worse.”

What can you do?

All assets are inflated as investors look anywhere and everywhere to provide profits. Gold is high, house prices are at an all-time high, even art/wine and classic cars are high. There is almost a desperation to it all. Where can value be found?

Within global stock markets, there will always be value out there somewhere. We still strongly believe that the FTSE is underpriced, but that is not an answer on its own.

We built The Portfolio Platform to enhance yields for investors. To give them access to professional traders. This becomes even more important in difficult times like this. Yes, many traders have been caught out by falling stock markets, but if we’ve seen the worst, and all that happens now is they fluctuate, traders can still make money.

Active trading is our answer. It’s what we do and it’s what we will continue to do for anyone who wants what we would consider to be a truly diversified portfolio. In our opinion it’s not about looking for value at the moment because nearly everything is expensive.

We’ve had a welcome dip in equities and they will move around a fair amount, but within that movement, money can be made. Selling out after a good run and waiting for the next opportunity as many of our traders do, doesn’t need an upward trending market.

It’s true that a falling market can cause problems, but ultimately, we aren’t suggesting equities will fall, only that they might not rise very much. If you had invested in the FTSE 5 years ago, you wouldn’t really have made any money at all. But if you traded in and out, taking advantage of dips and selling out high as our traders will try and do, then opportunities have been abundant.

Bonds, and especially government bonds will be the real losers of the tapering period and they are your ‘safe’ assets held in your portfolios elsewhere.

We focus on equities, but with a more active attitude. If the market rallies a few per cent, it might be time to get out and wait for it to fall in order to buy back in. That means you can make that money all over again.

This will happen many times throughout the year and we are likely to hit a cycle where we will see it regularly. If 3% is what is being offered, step away and look at our more active strategies.

An IFA who suggests right now that they can offer the same returns they’ve been getting over the last 5 years, doesn’t understand the market, but then why would they? They are salesmen and not traders. It isn’t their job to trade the markets, merely repeat what they have historically known.

Sadly for them, ignorance is no longer going to be bliss, it’s going to cost you as the value of your portfolios stagnate.

For more information about The Portfolio Platform please contact our team here.

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