Centering a client's core portfolio on U.S. equities -- usually with the Standard & Poor's 500 Index as a primary benchmark -- has been a hallmark of many advisors' approach to asset allocation. It worked especially well in the late 1990s, when large company U.S. stocks soared relative to many other asset classes.
An entirely U.S.-focused investment strategy hasn't worked well for much of this decade. This is not only because international stocks have outperformed for several years, but because other classes, such as commodities, and other factors (such as currency and geopolitical risk) have played increasingly important roles in generating competitive client results.
What's behind this long-term trend? And what solutions can active management offer? In our view, flexibility and uncertainty are the hallmarks of a new global business and investing paradigm we define as global rebalancing. Since the bursting of the dot com bubble in 2000, we have seen a shift away from growth dominated by the U.S. and toward a path where more countries contribute -- especially emerging and developing countries.
For example, our overseas trips since this past autumn brought to the fore direct ties between emerging markets such as China and Brazil, India and Indonesia, the Middle East and Russia. There are two implications to this: (1) There is less reliance on the U.S. as an export market, and (2) there is less reason for a country to tie its currency (and monetary policy) to the U.S. dollar, especially for sovereign wealth funds. This is a sea change in the global economy. As the world becomes less U.S.-centric, the economic center of the world is changing.
What we are also seeing - from the Persian Gulf to India to China -- is a more integrated, global approach to economic development than in the U.S. More businesses recognize that they are part of a bigger picture. For a country's power supply to increase, the power equipment provider must have the capital to increase capacity and production. To get that equipment to the utility, new high capacity roads, ports and rails must be built. In order to finance that activity the utility relies on financing authorities and infrastructure funds. When the power is in place, it raises an economy's growth potential. Along the way, all of the activity provides more people with jobs and higher incomes.
As portfolio managers, we attempt to capture this global dynamic with a go anywhere at anytime asset allocation strategy. In an equity market where we have seen growth become "the new value," with sector-wide blow-ups in financials and with relentless globalization across asset classes, we think flexible, outside-the-nine-box thinking as a core portfolio strategy offers multiple benefits. For instance:
- It frees advisors to focus on a client's long-term strategic goals
- Less time is spent on tactical portfolio repositioning based on asset classes currently in or out-of-favor.
- It is a more value-adding, real world approach than gimmicky or cookie-cutter solutions such as target maturity, static allocation and life cycle investment products.
One side of the global rebalancing coin is that the U.S. will begin repaying the tremendous debts it has built up over the past several years -- and a lot of that debt is owed to foreigners. We are already seeing initial evidence of this in terms of the merchandise trade and current account deficits. While some see this trend as a positive - which it will be once it runs its course - in the near-term it means U.S. economic pain as growth slows due to reduced consumption and increased savings. Thus the S&P 500's reign as a linchpin of asset allocation will, in our view, become less and less valid over time.
As advisors, if you can offer a core portfolio with maximum flexibility to go where the opportunities are best, we think you will have a distinct advantage in retaining clients during exceptionally volatile periods like we've recently seen.
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