Diversification is difficult at the moment. We know already that the traditional balanced fund, split between bonds and equities, is not best equipped for a market in which both asset classes have been prone to move in tandem.
More recently, it is oil’s ups and downs that have begun spilling over into other areas, a development that, we’re told, shows little regard for those utopian ‘fundamentals’ about which we hear so much.
This sounds like a convenient excuse for underperforming fund managers, and it’s true that some of those who’ve been more successful disagree with the thesis. Henderson’s UK absolute return managers, for instance, say they see “rationality” in current markets.
However, a look at January’s market moves does show a tight correlation between equities and crude oil – the closest in 25 years, according to one analysis – and credit indices are similarly connected to the black stuff.
It’s getting to the stage where tipping value to outperform is starting to look like the infamous ‘widow-maker’ trade of shorting Japanese government bondsWhat does that mean for approaches to risk? One obvious answer is to simply wait it out. Another would be to look a little closer at these correlations and attempt to identify outliers.
The most obvious deviation from the norm within equity markets, it seems to me, is value stocks.
Most intermediaries will be aware the style has underperformed for nigh on half a decade now. It’s getting to the stage where tipping value to outperform is starting to look like another version of the infamous ‘widow-maker’ trade of shorting Japanese government bonds, so-called because of its propensity to fail in perpetuity.
While the particularly strong divergence between value and growth last year has made some managers confident that a reversion is inevitable, this could just as easily be another year of disappointment for value investors.
But might the style, if nothing else, provide some diversification in portfolios?
Analysts at Citigroup have suggested as much. They suggest an environment of “value versus everything else” is not only a warning of how overcrowded certain areas of the market are. It also means the style is a valuable source of diversification.
While it’s true to say that plenty of commodity stocks have become value positions in recent months, taking exposure to the style doesn’t have to mean lining a portfolio with oil plays. Oil and gas currently make up less than a quarter of the MSCI UK Value index.
So if Citi is right to claim that, at a style level, value is “the only diversifier”, it’s food for thought for those still focused on growth strategies.
Dan Jones is editor of Investment Adviser