We regularly receive asset allocation reports from dozens of major managers. I’ve also had the pleasure of attending three separate meetings with one of the world’s largest fixed income managers over the past quarter, as part of a regular schedule of learning sessions for Tiger 21 members. What I heard was nothing less than a wake-up call on asset allocation.
I asked these managers what kind of return they’re telling their pension fund clients to expect on fixed-income portfolios over the next five years. Their answer: 2% to 3% returns on index-like portfolios (portfolios that aren’t actively managed).
This expectation of ultra-low returns has profound implications on asset allocations. Those who continue to put their asset allocation on “autopilot” may be in for a rough landing. That’s why I call it a wake-up call.
Here are several things we’re doing with our high-net-worth (HNW) client allocations.
Boosting equity exposure: In the past, a 60/40 split between equities and fixed-income investments (primarily government bonds) was the “go-to” allocation for 90% of individuals 90% of the time.
This model portfolio may be obsolete. Think about it: if 40% of your portfolio is earning 2% to 3% a year, that amounts to 0.8% to 1.20% for the portfolio as a whole. That puts a significant burden on the rest of your portfolio just to keep up with inflation, much less build wealth.
We recommend a 40/30/30 split between long equities/fixed income (long and short credit strategies) and alternative investments (authentic hedge funds) as a viable allocation for most of our HNW investors.
Thinking beyond bonds: We’ve been interested in investment-grade corporates and high-yield bonds for some time now. Geographic diversification is also a good idea: emerging markets may be less of a credit risk than developed markets. With bonds, we’re keeping duration short to minimize interest rate risk.
Alternative portfolio strategies: I’m thinking particularly of long-short managers here, both on the equity and the fixed-income side. The idea being that in a range-bound market, investors who can make money on the downside as well as the upside will be at an advantage.
Raising U.S. exposure: Currently, Canadian investors have a tremendous overweight in Canadian equities and bonds. But the U.S. won’t stay down forever. We’ve been allocating more to U.S. markets over the past several quarters, in large part because of the growth potential we see in the U.S.
Raising cash: We’ve taken the opportunity to raise cash – primarily U.S. dollars. Mostly by trimming speculative positions and being cautious about high-risk stuff. While core positions are being maintained, this is not a time to go “all in” on anything.
Global opportunities: Now, with Europe and North America tipping into or crawling out of a recession, it makes sense to broaden the geography of your portfolio. Some emerging markets are very cheap now; Japan, too. Equities can make sense here, but global convertible bonds are another possibility.
Aiming for tax efficiency: Tax efficiency can add an extra 1.25% to 1.5% to your returns annually. In this low-return environment, it can make a tremendous difference. Now more than ever, it makes sense to take advantage of return-of-capital structures, corporate class investments, RRSPs and TFSAs, etc.
I want to be clear: I’m not saying everyone will need to alter their asset allocation. What I am saying is you need to think about asset allocation. If you assume things will take care of themselves, you could pay for it. •
