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06/04/2012 8:30 am EST
Markets like this will make even the pros second guess their decisions, so it's no surprise if you're feeling less than sure about your strategy, writes Yves Bonzon for The National.
It's never easy deciding on a strategy for equity allocation, more so if you are a "do-it-yourself" investor in these uneasy times.
Yves Bonzon, the chief investment officer at Swiss-based private bank Pictet & Cie, says a diversified portfolio is key to spreading risk. However, he warns investors to think twice before investing in countries that are overburdened with debt.
1. The Art of Investing
One of the constants in the skilled art of investing lies in uncertainties surrounding any forecasting of returns from asset classes, particularly over the short-to-medium term. As a bulwark against the vagaries associated with this forecasting uncertainty, diversifying investments in a portfolio becomes a must.
The problem facing investors today is that all the time-honored recipes for diversifying portfolios, by allocating investments by asset class and by region, are turning out to be increasingly inefficient in a globalized setting. In fact, they look disconcertingly vulnerable to systemic risks stemming from the huge debt mountains crippling a whole host of countries.
2. Structural and Cyclical Factors
Ever-tightening correlations between equity markets can probably be attributed to a couple of root causes. The first is structural—globalization, free movement of capital, and tumbling transaction costs. The second is cyclical, related to the sovereign debt crisis.
Looking at a timescale stretching over a number of years, this factor will presumably subside, but there are far fewer reasons to gamble on the likelihood of the structural cause disappearing. Only wholesale reversal of the trend towards globalization, underway for more than two decades now, might be capable of bringing that about.
As diversification by national market or region no longer seems to be delivering the desired benefits, we are overhauling our approach to asset allocation by deciding to earmark clients' capital for investment by strategy and by risk factor, rather than along the more conventional lines of a split by asset class.
Incidentally, it is worth bearing in mind that distinctions by asset class have more to do with legal norms than economic logic. For the equities portion, our new approach divides the allocation into three distinct segments: defensive shares, growth shares, and tactical allocation through index-based instruments.
4. Defensive Shares
Defensive shares encompass several different approaches to investing in equities, depending on whether the portfolio is invested directly in shares or via equity-investment funds. The purpose is to secure, over time, a return that matches that of the market, but with slightly less volatility.
To achieve this, the focus would be on minimum-variance funds and strategies based on dividends or buy-write style strategies, such as portfolios with a systematic strategy of writing call options on underlying securities.
When it comes to investing directly in individual shares, the allocation will be invested in blue-chip stocks with very low cyclical and market sensitivities. In this area, we are looking to take advantage of the so-called "low-beta" anomaly, and of the fact that, over the long run, defensive shares tend to deliver a return equal or superior to markets. This seems to stand at odds with modern portfolio theory, but it is one that has been tried and tested in reality.
Of course, as is often the case in the world of finance, there is no such thing as a "free lunch". The price to be paid will be occasionally quite protracted spells when investors' frenzy for a fad play will result in defensive shares and strategies underperforming quite noticeably.
5. Growth Stocks
Growth stocks also cover an array of sectors, although their common denominator is the existence of a structural underlying trend running in their favor. At present, this is the case for oil-services stocks.
We believe the real challenge relating to oil supplies lies more in the access to the oil and in the cost of extracting it than in the physical existence of adequate reserves. Furthermore, many national oil companies are not publicly listed on stock exchanges. On the other hand, every single one of them has to lean on expert assistance from specialized oil services firms to get at the oil deposited in ever tougher and challenging geological formations.
6. Tactical Allocation
Lastly, a portion of the equity allocation is given over to a third compartment on the basis of our proprietary quantitative indicators. This comprises a "pocket" of capital geared towards tactical plays. On the grounds of pragmatism, we resort to index-based instruments that are more compatible with the shorter-term investment horizon.
7. The Result
These three allocations will, inevitably, be correlated between each other. The purpose behind this approach lies in drawing a clear distinction between the three equity strategies, corresponding to different investment time frames and regimes, in terms of the crucial twin factors of economic growth and inflation.
Above all, though, its roots can be traced to behavioral finance theories, and the approach enables us to take advantage of structural phenomena, such as low-beta anomalies, while simultaneously minimizing innate contradictions between fiduciary responsibility towards clients.
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