Derisking your portfolio in a post-Covid landscape

Most investment experts are agreed that traditional asset allocation rules are off the table, not least because, as Matthew Morgan, investment director in the multi-asset team at Jupiter Asset Management, says: “Today, developed government bonds yield very little, and have been losing money in recent months.

“Markets are in uncharted territory because central banks and governments are doing more than ever to create inflation and growth, and this could lead to higher interest rates and further losses from government bonds.

There is no instruction manual for dealing with 2020 and 2021 and so diversification and flexibility remain important Douglas Kearney, Intelligent Pensions

“The answer to the problem is to be innovative and dynamic. There are other ways of building resilience into portfolios through the cycle such as using long and short positions in portfolios to access relative value, alternatives, active currency, and volatility. Dynamically evolving through the cycle is also key; setting and forgetting your asset allocation is likely to underperform.”

Diversification and flexibility

Derisking is certainly more challenging these days says Matthew Yeates, 7IM’s head of alternatives and quantitative strategy, pointing to greater use of credit instruments, alternatives such as market neutral strategies, real estate investments and occasional use of specialist fixed income areas that “makes more sense than piling into the historically ‘safe’ havens of government bonds”.

While Douglas Kearney, investment director at Intelligent Pensions, warns that he sees some asset allocations prescribed in industry rules and frameworks suggesting very high exposure to government bonds of circa 40 per cent plus, which “would not be the smartest move right now”.

He says: “There is no instruction manual for dealing with 2020 and 2021 and so diversification and flexibility remain important as the world’s economies recover from the pandemic."

The current phase of the business cycle is of rapidly increasing profits, after a severe downturn, against a background of low but rising inflation, says Tom Elliott, senior investment strategist at Mattioli Woods.

“Investors usually respond to this combination with an overweight position in equities relative bonds. ‘Derisking’ in the current environment, therefore, means positioning portfolios in such a way as to benefit from inflation, or at the least reducing the possible harm that inflation may exert on a portfolio,” he says.

“This means reducing overall exposure to fixed income, since rising inflation will continue to push up bond yields. A switch into asset classes such as gold and equities may be suitable, since they have a better history of retaining their real value in the face of inflation.”

Within fixed income portfolios, derisking might include reducing duration and even building up cash positions with the intention of creating dry powder to re-enter the bond markets when yields have peaked, he argues.

On the defensive

Now that the default choice for prospective retirees is no longer to purchase an annuity, how does this change portfolio construction for the longer term? 

Kearney captures the dilemma around the growing dependence people have on their portfolio as they get older, meaning exposure to defensive assets should increase to reflect the unwanted volatility and risk.

“The government bond safe haven is really no longer with us. A broad mix of lower risk and less volatile assets remains key. It is also important to carry some equity too, as this should help offset inflation, which is ever present,” he adds.

For Yeates, the increasingly small numbers taking an annuity payment and the logic of derisking up to the selected retirement date no longer makes sense, as many people are staying invested long beyond their retirement. 

“Many investors should not be looking to automatically derisk. Following such an approach may increase the risk of not hitting their retirement goals,” adds Yeates.

Elliot says the response from financial advisers has been to compensate for the increased risk for those entering retirement still invested by diversifying the source of returns (and of risk).

They have been helped in this by the fund management industry, which has developed a broad range of multi-asset funds.

“The days of a balanced fund being just equities, bonds and a little property are gone. Instead, we have a broad range of ‘alternatives’ that we can add to multi-asset portfolios. These will include asset classes that, 20 years ago, were relatively inaccessible to the average client, such as exposure to private equity and infrastructure,” he says.

So how is portfolio construction today impacted by long-term changes to how we live, work and consume?

Longevity is one of the greatest risks, given most investment portfolios do not provide enough growth to compensate for this, says Shaniel Ramjee, senior investment manager, multi-asset, at Pictet Asset Management.

He also notes the risk of higher inflation requires a more equity growth objective, so investors that are too conservative in their investment decisions might find they fall short of objectives.

“Asset allocation styles that are able to derisk completely by meaningfully changing the asset allocation to defend capital will be needed to avoid disastrous years in markets."

On the cusp of change

Guilhem Savry, head of macro and dynamic allocation at Unigestion, highlights current themes – such as digitalisation or environmental, social and governance considerations) – that illustrate how the way we live, work, consume and think interacts with asset returns and portfolio construction.

“Climate risk should be integrated into portfolios,” he adds.

Kearney says: “The speed of change has been immense over the past year. The most amazing achievement has been the discovery, production and distribution of a vaccine in months.

“The impact on medical science is, in my view, at the foothills of enormous developments and that change is perhaps not truly recognised yet.”

Mark Battersby is a freelance journalist