Asset allocation was once a straightforward process for multi-asset investors.
The prevailing economic and market conditions determined the proportion of bonds and equities held within a clients portfolio, and more often than not that equated to a 60/40 split between stocks and fixed income.
The theory underpinning this is that government bond and equity prices move in opposite directions to one other, such that in times of buoyant markets, equities perform well, and in tougher times, government bonds do well as investors rush for safety.
But the decade since the financial crisis has seen government bond prices rise steeply, while equity markets have also risen sharply in value, presenting challenges for those adhering to established asset allocation methods.
One test of the durability of portfolios came with the pandemic-prompted market meltdown in March. On that occasion, “government bonds did the traditional job expected of them”, according to Keith Balmer, multi-asset fund manager at BMO.
He says: “The challenge with trying to build a diversified portfolio is that at times of severe market stress, all correlations among all asset classes go to one.
"But in March, after an initial wobble, government bonds did their job and performed well. There have been many pretenders to the crown in terms of being a diversifier, but nothing has performed as well as that this year.”
Exposure to dollar assets
The UK 10-year government bond yield has fallen from 0.8 per cent to 0.2 per cent in 2020, and as the yield falls when the price rises, this represents an capital gain for investors.
Mr Balmer says the other way he tends to diversify is by taking exposure to investments in a wide range of markets, rather than being overly exposed to the UK.
He adds that having exposure to US dollar assets is also a crucial part of building a diversified portfolio, as the dollar tends to perform well in times of uncertainty, as occurred in March.
The dollar tends to perform well when uncertainty is at its height partly because US companies and individuals bring cash they had invested overseas back to the US, and convert it into dollars to help them ride out the storm.
The second reason the dollar performs as a safe haven is investors around the world buy US government debt, believing it to be uncorrelated to equity markets.
Mark Jackson, product specialist on the multi-asset team at JP Morgan Asset Management, notes that the US 10-year government bond yield from almost two per cent at the start of the year to as low as 0.3 per cent in March as investors moved in.