Fed-watching. Oil prices. The latest geopolitical headline. All sources of anxiety, some of them manufactured. The real question is, what should you be focusing on?
Even as markets persist near all-time highs, volatility not indicating too much concern, the subconscious anxiety appears to be growing. As we’ve seen in recent years (and, more recently, during Brexit) any number of things can create uncertainty in the market and cause investors to make a kneejerk reaction. The key is avoiding that.
Such event-driven market gyrations raise the questions about how investment professionals and their clients should make portfolio decisions. How you construct your portfolio goes a long way in how you view market activity. While there is no shortage of so-called rationale for buying and selling (as the cable TV pundits will attest), solid portfolio allocation decisions require equally solid rationale.
In other words — What are you looking at?
Investors who don’t make investment decisions based on specific rationale are more apt to put their money on the line based on what they think/hear or, worse yet, on attempts to time the market. The New York Times recently highlighted the potential danger of such an approach: “By buying and selling too frequently and at the wrong times and not benefiting fully from compounding, people typically do even worse than they would have done if they simply held on to their investments.” Investors get penalized for being reactionary. The less fundamental and the more ad hoc their reasoning for making asset allocation decisions, the more susceptible investors will be to react to market noise.
We believe a macroeconomic-driven asset allocation, at least for a portion of portfolios (i.e., the strategic or dynamic holdings—typically 20%), make the most sense for investors to construct portfolios that are adaptable to the current environment, while also maintaining their focus on long-term results. After all, corporations focus on economic trends. The Fed focuses on economic trends. Why wouldn’t investors?As a fundamentally driven asset allocation firm, we’ve made our careers determining why economic data matter—what data points mean and where the economy is going. Our macroeconomics-based approach is all the more important in today’s evolving capital market landscape, with potentially changing risk and return dynamics, from fixed income and more assumed risk in traditionally allocated portfolios. As we observe, in these conditions, investors are taking on more risk to pursue the same return.
For example, in today’s investment environment, realistic fixed-income return targets are becoming harder to achieve without taking on more risk. The choice for many investors has been to take on more risk for the same yield‘(1):
- In 1995, a 100% portfolio allocation to Treasury Bonds would have an approximate 7.5% target return, with a 6.5% standard deviation.
- In 2015, to have a 7.5% target return:
- Treasury bonds were reduced to 12% of the portfolio
- Equities were almost two-thirds of the portfolio
- The standard deviation for the target 7.5% return portfolio rose to more than 17%
‘(1) Source: Wall Street Journal/Callan Associates: http://on.wsj.com/1XN7VyS
Without a rationale grounded in the fundamentals, investors potentially could make risky decisions without having a good reason—or worse, decisions that are not in line with their risk tolerance, which will put more emphasis on managing risk for the foreseeable future. This adds more weight to have a good answer to the question: What are you looking at?
At Astor, we believe the only acceptable answer is the economic fundamentals. That’s what matters when you’re focusing on what matters to you.
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