Nordea Asset Management has waded into the debate on the merits of 60/40 portfolios, arguing investors need to look to “differentiated approaches” to balancing risk following the turmoil that swept through markets in 2022.
Following the recent call of Apollo Asset Management for investors to introduce a higher weighting in absolute return funds going forward, Asbjørn Trolle Hansen, head of the multi assets team at Nordea Asset Management, argued investors should consider the opportunities in “alternative risk premia”.
“We believe investors can capitalise both cyclical and anti-cyclical return drivers from a broad and diversified set of 30 risk premia spread across strategy types and asset classes,” said Trolle Hansen.
For example, as an alternative to traditional government bonds in recent years, Trolle Hansen said Nordea Asset Management has utilised areas such as currency-related risk premia.
“Attractively valued currencies can provide pleasantly defensive characteristics, the simplest example being the Japanese yen versus the euro,” he said.
So, what has gone wrong for the 60/40 approach?
Trolle Hansen said with numerous asset classes performing positively in unison since 2009, most multi asset approaches – including the 60/40 – largely delivered on long-term investor objectives.
However, as turmoil swept through markets last year, sparked by aggressive central bank action to tame inflation, he argued that most traditional diversification methods were “found wanting”.
“In our view, traditional diversification has for some time not been able to protect investors to the extent it used to,” Trolle Hansen said. “The ‘correlation perfect storm’ we witnessed last year was a painful reminder of this.”
He added while risk assets have enjoyed a strong start to 2023, bouts of heightened turbulence are likely to become a feature of the market environment for the foreseeable future, as central banks continue to hike rates in an attempt to cool inflation and the damaging war in Ukraine continues.
Set the mood
Yet despite these challenges, Trolle Hansen said it is “not all doom and gloom” for investors.
“At the beginning of 2022, expectations for equity beta and duration risk premia were 4.5% and 0.3% per annum, respectively,” he said. However, because of the events of last year, this has now increased to 6.3% and 1.4% per annum.”
Trolle Hansen said Nordea is particularly optimistic on stable/low risk equities, which he argued have demonstrated an ability to perform through periods of heightened volatility – as well as periods of elevated inflation.
“As is commonly known, equities offer the highest return potential within a multi-asset strategy, but the asset class is also the greatest source of risk,” he said. “Therefore, it makes sense to identify companies displaying a greater degree of solidity in stock price, earnings, dividends, Ebitda and cash flow than the broader market.”
In Nordea’s view, stable, high quality and attractively valued companies – which historically offer more resilient earnings – are naturally in a far better position to navigate through this continually challenging economic backdrop.
“In addition, we look for companies exhibiting pricing power, which have the ability to pass on inflation price increases,” Trolle Hansen said. “This is a valuable characteristic in the current climate.
“Also, stable/low risk equities continue to offer a 1.4% earnings yield premium versus the broader market. This is an incredibly attractive building block for portfolios in the months and years to come.”