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What's A Smart Asset Allocation These Days?

Christian Armbruester, 15 June 2020

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Blu Family Office, the European firm, has regularly commented on investment issues in these pages, and we welcome it back for an analysis of how investors should position at times such as this.

Markets fell again last week, halting a recovery from March lows and reminding everyone that the COVID-19 pandemic isn’t over, and nor is the economic pain the lockdowns and social distancing measures have caused. Allocating assets in such an environment isn’t easy – can one really just sit back and let market indices move around? What ought to be the smart way to position portfolios at a time like this? 

This news service has written recently about the insights of behavioural finance, an approach grounded in an understanding of how people’s mental habits, acquired over hundreds of thousands of years, can lead them astray. And often the conclusion is that investors frequently sell out of a market when in fact they should have stayed in, or vice versa. But that sort of insight, while sounding very smart, may be too neat for its own good. Not everyone has the same time horizon, for example. Does quoting behavioural finance talking points really work with someone in their 60s who is about to retire? 

To jump into the conversation is Christian Armbruester, the founding principal and chief investment officer of Blu Family Office, the European organisation that is based in London. Armbruester has written a number of commentaries for this news service, and we’re pleased to invite him back. As always, this news service doesn’t necessarily endorse all views of guest writers, and invites replies. Email tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com

The investment environment has changed dramatically this year. Not that the previous years were not that interesting, but 2020 will certainly live in our memories for a very long time. There were simply so many extreme price movements across all asset classes, and the numbers were just frightening. We have more unemployed since the great depression, we had the largest drops in global economic output since the great wars, and the amount of monetary stimulus from the central banks was unprecedented. To date, more than $20 trillion of government bonds have been issued globally to stem the effects of what could be the greatest financial and economic crisis of all time. Lest we forget, it is only June and our quandary with the coronavirus is far from over.

So, what to do in an environment like this and how should we position our investment portfolio in such uncertain times? Whatever you do, don’t do what you did before. The world has changed, and if we don’t adapt, we are going to be dinosaurs in a digital world that is moving at lightning speed. Foremost, our options for investment have not only changed, but very importantly there is now a new price for risk. It’s like going to the supermarket and finding that a box of cereal now costs $100. First thing you do, is you look around, and to your horror it wasn’t a typo on your favourite box of Weetabix, and even the basic Corn Flakes are now commanding triple digits for our morning breakfast. Clearly, we leave the supermarket and go to our local, but there as well we see that cereal now costs what it does, and government debt is yielding zero per cent.

What’s more, the cereal could be tainted and by that we mean that even if we were to buy government bonds at zero per cent returns, there could be the risk that if certain things happen (like inflation), we could lose much of our investment capital. The thing is, after printing $25 trillion for quantitative easing to fight the great financial crisis of 2008, and now having to do much more of the same, you are reminded of the renowned banana republics that we read about in economic history and you wonder how it all works? So, if they keep spending more than they have and they keep printing money to pay that tab, wouldn’t this whole thing fall apart at some point, because there is no free lunch? Well, there is always the next generation that can pay for it all, but that is another discussion.

If not government debt, what about equities then and how much should we allocate to this asset class? Equities are great, they tend to go up in the long run, but there seems to be quite a bit of downside risk at the moment. However never fear, as at 10th June and the writing of this report, equities had erased almost all losses for the year. Whether or not that will be the case at the end of this year, or whether we will go back to making new highs in ten years, is not something anyone can answer. The point is, equities swing a mighty hammer. They can drop by 50 per cent at any time, but for the last 100 years they have gone up on average by 8 per cent per year. That’s the risk and reward and all we have to decide is how much of it we want to take.

In the past, we combined the high risk of equites with the low risk of government bonds. Now we can no longer do that, because the risk is the same, yet the payoff much different as per our prior analysis. So, really the question becomes, what else can we combine with our stock portfolio so that we don’t risk losing too much? There is property, but that is an illiquid asset and whereas a stalwart of any private investment portfolio, it is where we live, not something we should invest in by buying a few buildings. Real estate is a local market, and diversification only comes through buying many properties across many regions, countries and price points. We can get that exposure through REITs, or companies that do property development, estate agents or manage commercial offices. Funnily enough, the most efficient way to get exposure to real estate is through equities, and as such not something we need to worry about.

What about commodities? They most certainly went up and down in April when we could acquire a barrel of oil and get paid for it. Yes, the forward contracts for April went from a price of $60 to negative $37.

Still want to invest in energy, base metals, grains, or orange juice futures? The thing about commodities is that you have to store and consume them to extract the value. As a long-term investment, commodities are completely useless and if you are still not convinced compare buying oil with buying equities in the eighties. Hint, one went up by 3500 per cent, the other remained flat. Enough said.

Private equity? Sure, but again it is illiquid, high in fees and I am still not convinced a company that makes widgets is worth more when it is private versus in public ownership. Gold or other precious metals? Maybe, as the ultimate store of value in an Armageddon scenario, but there is no reason why gold should either go up or down by 30 per cent from these levels. There is also the storage problem as with all commodities, and you could run into the same problem as the energy markets in that the costs could far exceed supply.

Apart from Bitcoin, this is usually where conversations end for most people when they think of investing. Note, that in everything we have discussed thus far, we have always bought things, from bonds, to equities, property, and commodities. But of course, in today’s world of investing, we can also sell things we don’t have, speculate on prices falling and buying things back for profit. Very risky of course, and that has to do with maths. If you buy something at 10 and it goes to 0, you lose 10. If you sell something at 10 and it goes to a hundred, you lose 90. Which is why the regulator has deemed such practices as too risky for the amateur investor, and hence only professionals (and HNWs) can get access to investment strategies that are wrapped in so-called hedge funds.

The thing about hedge funds is that they are widely misunderstood. Maybe it is because being allowed to do whatever you want as long as you make money, is not the most comforting thing you want to hear about an investment strategy. Mostly though, it has to do with the fact that there are so many different strategies that don’t just buy and hold, it is really impossible to group them all together and even worse call them “alternatives”.

To be clear, there are strategies that are extremely low risk and that is because they can also sell things. Remember our dilemma with equites in that they could fall by 50 per cent? Well, what if we hedge that by selling one for the other, we can eliminate a lot of that risk in so-called market neutral strategies. There are also market neutral commodity, corporate bonds or other index arbitrage strategies; there is structured credit, private lending, convertibles, private debt, event driven, trend following, and even cryptocurrency Lombard lending. And if you are as confused as anyone, given such an opaque and diverse investment universe, just think of all the possibilities in which you could now structure your investment portfolio.

Rather than be scared of alternative investment strategies, we should all embrace them and thank our lucky stars for the propensity of financial markets to find ever more diverse opportunities to make money.

Buyer beware of course and make sure you understand what it is that you are putting your money into, but any diversified and efficient investment portfolio should have at least half of the money allocated to something other than equities. Everything else would be uncivilised and far too risky.

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