It may now be time to look beyond the mega-cap stocks and core bonds that have been a staple of investment portfolios in recent years.
The times and tides are changing
Barack Obama had the distinction of being the only U.S. president who never experienced a down calendar year for the S&P 500 in any of his eight years in office. But he presided over an anomaly: Interest rates have been at all-time lows for eight years, resulting in a rising tide of accommodative Fed policy that has lifted all boats in the equity market.
However, after raising its benchmark interest rate in December 2016, the Fed hinted at subsequent upticks in the near term. As interest rates increase, the market may be driven more by earnings growth and company-specific fundamentals, and stocks will need to be considered on their individual merits. Risk management is always important, but it could be even more critical in this environment. Getting the most out of portfolio diversification may be a good place to start.
What’s needed now?
Our research shows that many investors are instinctively aware of the need to improve diversification. Three-quarters1 say they want new strategies to help them better diversify their portfolios, and the same number want strategies that offer a better balance of risk and return. Delivering on those needs may require new ideas. Financial advisors are seemingly challenged to deliver true diversification in today’s markets, and the majority2 say traditional style box analysis no longer provides adequate diversification for client portfolios.
The proof is in the portfolio
Given these new market realities, diversification may need to go beyond the basics of adding more asset classes and investment styles to client portfolios. As the chart below demonstrates, analysis of our Moderate Portfolio Peer Group3 reveals that the most broadly diversified portfolios have performed the best during recent periods of volatility, but it also identifies a very specific common characteristic among the top performers: large allocations to non-correlated asset classes.
This provides an essential insight for portfolio construction. “Diversification Benefit” is a critical consideration. A measure of the percentage of risk diversified away through low correlations across holdings, this metric illustrates the impact of correlations on mitigating risk and drawdowns.
Putting the strategy to work
Advisors and their clients can start by asking if portfolio holdings are delivering on Diversification Benefit. If your portfolio doesn’t measure up, consider opening up your holdings to a more diverse range of asset classes, paying close attention to correlations. When markets are volatile, every allocation counts.
1 Natixis 2016 Global Survey of Individual Investors
2 Natixis 2016 Global Survey of Financial Advisors
3 The Moderate Portfolio Peer Group compares performance and asset allocations of Moderate Model Portfolios submitted to our Portfolio Clarity team with each other and selected benchmarks. Data represents 330 portfolios submitted by financial advisors from 4/1/16 to 9/30/16 and 2,377 portfolios submitted from 1/1/13 to 9/30/16.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Diversification does not guarantee a profit or protect against a loss.
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.
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Advisors can help their clients understand the potential effects of interest rate changes.