With uncertainty over the prospects for global equity and fixed income markets, many advisers are considering how they go about constructing portfolios to meet the new investment environment.
Clients want portfolios that provide a higher degree of certainty that they will achieve their real investment objectives i.e. that are not just focused on delivering a return that is relative to the market.
Also rates on cash and term deposits (that are seen as the traditional ‘defensive’ investments) have fallen to 3-4 per cent and many fixed income investments such as government bonds are seen as overvalued and subject to capital losses if interest rates rise.
‘Relative return’ strategies are those that are managed against a benchmark index. These strategies performed well during the bull markets in the 1980s and 1990s because most stocks and bonds produced strong returns over the period.
However, investors have more recently experienced two severe market downturns (March 2000’s bursting of the dot-com bubble and 2008’s global financial crisis). These downturns challenged the performance of traditional, relative return-oriented portfolios.
The dramatic declines and increased volatility in the equity markets brought on by the latest financial crisis have left many investors looking to diversify their equity-like exposure. The feedback from investors is that beating a benchmark that is down 20 per cent is little consolation to them. The result is that many advisers are rethinking their clients’ portfolios.
As a result, real or absolute return investments have been increasing in popularity. These investments can provide diversification with little or no correlation to traditional stock and bond benchmark-aware strategies. They are also able to utilise a broader range of investment tools than traditional portfolios. The focus is on delivering a specific risk/return outcome that is typically a return above cash, with lower volatility than the market.
The more an investor can reduce downside portfolio risk, the larger the ‘capital base’ from which a portfolio can potentially grow over time. A well-diversified portfolio, including an allocation to an absolute return strategy, can help limit losses in volatile markets.
Russel Pillemer co-founded Pengana in 2003 and has been chief executive since inception. He is a member of the Institute of Chartered Accountants in Australia and has a Bachelor of Commerce (Hons) from the University of New South Wales.
