Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 182

Managing dynamic asset allocation in unusual times

  •   17 November 2016
  • 1
  •      
  •   

The dreamers need the realists to keep them from soaring too close to the sun. And the realists? Well ... without the dreamers, they might never get off the ground.” - Modern Family

What better way to describe the importance of diversity of opinion? For a healthy functioning society, the existence of both dreamers and realists is critical. So too in markets. Disagreement, bulls and bears play a critical role in market stability. The problem arises when the balance is tipped too much in either direction or when disagreement is replaced with group think.

Taking the good with the bad

Consider 2006/2007’s extreme in greed versus the recent years’ extreme in aversion. Too many dreamers and no realists saw markets soaring too close to the sun. Having been burnt badly following the GFC, global growth still can’t get off the ground. It feels like a low-flying plane that constantly hits air pockets causing both occasional lifts and near-death experiences.

This is good and bad. It’s good because blind optimism hasn’t led to economic excesses and greed that tend to end in disasters. But it’s also bad, because there is little conviction in investing for the future at both corporate and household levels.

Still, good and bad is not necessarily unwelcome when it comes to investment opportunities. The divergence in investor opinion and the general lack of conviction in economic growth is leading to many opportunities as well as risks, and a world of extreme divergences.

At the heated extreme (not too far from the sun) is anything yield related, while down near the ground is anything risk related. The rationale is clear: the world is a mess, central banks are out of ammunition, the population is aging and judging by the experience of the past few years, growth will continue to disappoint for many years to come. It’s hard to argue with that logic and we don’t intend to. Our investment philosophy is built on scepticism. The sceptic in us says “when it is so obvious, it’s obviously wrong”.

And that must be what Mark Twain had in mind when he said: “It ain’t what you don’t know that gets you in trouble. It’s what you know for sure that just ain’t so.”

What’s certain?

So what does the market know for sure? That inflation will never come back, growth is as good as it will get and interest rates will remain near zero for many years to come. The polar extreme in relative performance and relative valuation of the low volatility theme (for example yield and defensive growth) versus the risk theme (for example value and cyclical growth) and the fact that more than 40% of the global sovereign bond index has a negative yield reflects the perceived ’no growth, no inflation forever’ backdrop.

In fact, much of the market appears crowded away from risk and value and into quality and low volatility.

Irrational investment behaviour

The search for yield started as a perfectly valid strategy following the GFC. But by now, a theme that was anchored around perfectly rational investment logic has morphed into irrational investment behaviour (when shares are bought for income and bonds are bought for capital gain).

The chase for yield, low volatility and quality has now become a crowded momentum trade. The self-fulfilling cycle of money pouring into low volatility and quality stocks leading to strong price gains, further supressing volatility, encouraging more flows and price gains has led to a false sense of security and confidence in making easy money. Our inner sceptic tells us it can’t be that easy. The momentum spring can’t stretch forever. Eventually it will snap or it will spring back.

Here’s why: five years of fiscal austerity is giving way to fiscal neutrality, and while important risks persist and need ongoing assessment, there are signs that 2017 could mark a return to a more synchronised global economy, at least in US dollar terms.

The stability in the US dollar, improving commodities performance and rebounding inflation expectations all point to an unfolding regime shift. If so, the recent back up in sovereign bond yields has further to go. This poses both risks and opportunities.

Subsequently, this is how we’re managing our dynamic asset allocation funds:

  • To manage downside risk where diversification is extremely hard to achieve, we are increasingly using option strategies.
  • We’re staying away from low interest rate/low inflation winners of the past few years such as nominal bonds and bond proxy equity sectors.
  • We have a diversified exposure to low interest rate/low inflation divergence theme such as commodities, global banks, Japanese shares, emerging market equities, and currencies.
  • We have higher cash holdings as a defensive buffer.

Bottom line

The world’s glut of savings has now ended back in the US where it started, this time in low volatility, defensive, quality themes. These themes are expensive, over-owned, over-loved and vulnerable (ticking all the boxes for ‘avoid’ under our investment process). Still, we doubt any unwinding will be disorderly as central banks remain friendly, real yields remain negative (despite rising nominal yields), and global growth is showing signs of broadening.

 

Nader Naeimi is Head of Dynamic Markets at AMP Capital. This article is a general view and does not address the specific circumstances of any investor.

 

banner

Most viewed in recent weeks

Australian house prices close in on world record

Sydney is set to become the world’s most expensive city for housing over the next 12 months, a new report shows. Our other major cities aren’t far behind unless there are major changes to improve housing affordability.

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Latest Updates

Planning

Will young Australians be better off than their parents?

For much of Australia’s history, each new generation has been better off than the last: better jobs and incomes as well as improved living standards. A new report assesses whether this time may be different.

Superannuation

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Investment strategies

A steady road to getting rich

The latest lists of Australia’s wealthiest individuals show that while overall wealth has continued to rise, gains by individuals haven't been uniform. Many might have been better off adopting a simpler investment strategy.

Economy

Would a corporate tax cut boost productivity in Australia?

As inflation eases, the Albanese government is switching its focus to lifting Australia’s sluggish productivity. Can corporate tax cuts reboot growth - or are we chasing a theory that doesn’t quite work here?

Are V-shaped market recoveries becoming more frequent?

April’s sharp rebound may feel familiar, but are V-shaped recoveries really more common in the post-COVID world? A look at market history suggests otherwise and hints that a common bias might be skewing perceptions.

Investment strategies

Asset allocation in a world of riskier developed markets

Old distinctions between developed and emerging market bonds no longer hold true. At a time where true diversification matters more than ever, this has big ramifications for the way that portfolios should be constructed.

Investment strategies

Top 5 investment reads

As the July school holiday break nears, here are some investment classics to put onto your reading list. The books offer lessons in investment strategy, financial disasters, and mergers and acquisitions.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.