State Street on the Future of Portfolio Construction
Looking at the state of the world and what the future could hold, it's clear that future generations will be shaped by the shift in behaviors due to COVID-19. New industries will accelerate, while current ones play catch up to adjust to the new world order. The yield from a standard 60/40 portfolio of global stocks and aggregate bonds will need attention as well, as things have shifted since the last decade.
Based on a report by SSGA's Head of SPDR Americas Research, Matthew Bartolini, just as the pandemic has amplified certain societal trends, it has the potential to advance the deterioration of the 60/40 portfolio’s risk/return profile. As a result, structuring portfolios in and out of the core requires a more tailored approach to meet specific return objectives and ensure that the portfolio remains properly diversified.
The current economic environment is marked by a particular uncertainty that has led to a more volatile standing. Returns are more fragile than before. However, historical guidance can help set expectations. For example - for bonds, there is a strong relationship between the yield at the time of purchase and the
Rethinking The Core
Rethinking the core does not mean drastically altering the asset allocation mix between stocks and bonds. That said, with a lower expectation for returns, there are other approaches. Four key methods to consider as far as helping for a return generation:
- Target active management in areas where there is a strong track record of above-benchmark performance.
- Expand market coverage within the ACWI and Agg to seek out underrepresented areas or create a different risk/return profile.
- Structure portfolios based on factors that have historically earned a premium, and be patient and trust the process.
- Increase exposure to noncorrelated strategies to help navigate market uncertainty and provide a differentiated return path than the one just stocks and bonds would provide.
Understanding where to use low-cost indexed-based solutions requires understanding where not to use higher-priced active strategies. However, this is in the aggregate, and the need to understand a manager’s strategy and their individual propensity to outperform is required.
As far as more portfolio adjustment considerations are concerned, once some of the remodeled 60/40 portfolio goes active, indexed exposures can be further refined. Within equities, this means expanding a portfolio’s reach overseas. Ensure proper market-cap coverage by expanding into small-cap overseas while restructuring core bonds in a low-cost manner, with more precise control over yield and duration.
Finding the right means for analyzing factor specifics is important as well. It has been well documented in academic circles that stocks featuring specific investment traits have shown the ability to outperform the broader market and earn a premium over traditional beta. Constructing an exposure focused on stocks with these specific traits has historically earned a premium over the market. As far as a portfolio is concerned, one should consider Examining multifactor-based portfolios to replace certain core equity assets and the potential use of sector rotation portfolios within a US allocation.
With this next decade starting in a high-risk regime and the importance of diversification to mitigate what may lie ahead, seeking out noncorrelated strategies may be one way to bolster a portfolio’s defense. Think about paring back some of both the stock and bond allocations in the 60/40 portfolio and replacing them with an alternative strategy as a potential source of diversification — with the weight depending on investment-specific constraints and criteria.
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