In the last decade, the performance of the 60/40 portfolios has been exceptionally strong – this regime has been a clear outlier relative to the last 50 years. One could argue that broadening the investment opportunity set was not worth the effort during the last 10 years, writes Peter Warken, head of strategic asset allocation at DWS.
Unfortunately, a myriad of contemporary worries, such as geopolitical uncertainties, have been a drag to the year-to-date performance of equity-bond portfolios. Consequently, per end of May 2022, the 60/40 portfolio returned -10.9%, the largest decline for this allocation since 2009.
What makes things worse is that, unlike many previous periods of market underperformance, this time both equities and treasuries experienced negative returns. This reminds investors of the challenging market environment lying ahead that is characterised by volatility higher than the one we got used to.
Uncertainty in market conditions and longer-term challenges to real investment returns call for action. To meet financial goals in such a regime, investors must consider a broad range of opportunities and risks across global capital markets.
Which asset classes should be considered for the long run? What do these assets offer in terms of risk versus return? Do these investments enhance the portfolio diversification? Essential questions for strategic investors.
The global market portfolio
Over the past few decades, the global investment landscape has changed dramatically. DWS has a market value-weighted allocation, a global composite allocation with all sub-asset classes proportionally weighted by their market capitalisation.
Such an overview is increasingly relevant to investors’ investment discussions, especially of those investors who want to diversify their traditional equity-bond portfolios to achieve differing objectives and strategies.
Overall large-cap equities and developed markets sovereigns account for 56% of this allocation only. This demonstrates there are plenty of categories that investors can consider to potentially enhance the long-term return potential and to increase diversification.
However, this overview is not advocating for everyone to be invested in all those asset classes. Nor does it claim the weights are optimal. Different market regimes call for different allocations, and different investment objectives and scenarios require different exposures.
During the last few years, investors’ demand for alternatives has been steadily growing and the share of alternatives in the global market portfolio has also shown a noticeable increase. But one must be mindful of peculiarities of this asset class.
For instance, estimating the risk of infrequently traded assets presents a challenge due to opaque information. Moreover, it is important to remember that depending on the precise investment objectives, different types of alternative sub-asset classes and strategies are required as their portfolio effects can vary significantly.
Knowledge of risk
Having a fundamental understanding of your investments is also of utmost importance when adopting newly emerging asset classes such as digital assets. While this asset class currently accounts only for around 0.8% of the overall asset universe, the associated risk might be significantly higher.
For example, if one compares risk statistics of Bitcoin against traditional liquid asset classes, the former can boast a rather low correlation to the latter group, but investors should be very careful about this seemingly good news: in the worst cases of drawdowns, the digital currency might exacerbate the losses of the portfolio.
Additionally, understanding that there can be an extremely large dispersion of portfolios around the introduced global market portfolio is important. As different investors have different objectives and preferences, a vast range of individual portfolios is created.
The overall wealth, the ability and willingness to take risk, the investment horizon or liquidity needs influence the design of the optimal investment strategy. Everything considered, the right asset allocation and implementation are the two components that make an outstanding portfolio.
No ready-made formula
It is quite probable that we are currently witnessing tectonic shifts in financial markets, monetary policy, and real economy. These circumstances invite deeper exploration of markets in search of protection or risk-return improvements.
Nowadays investors can choose not only between listed equities and bonds, but see their universe expanded to assets as exotic as cryptocurrencies.
Naturally, varying investment needs and constraints are going to influence the actual portfolios and different investors would face very different implementation opportunities.
There is no ready-made formula for successful investment, but a good understanding of your targets and opportunities, combined with a systematic approach, can help mitigate many risks.
This article was written for International Adviser by Peter Warken, head of strategic asset allocation at DWS.