One legacy of the recent financial crisis is that many investors have become acutely aware of the greater possibility of extreme asset returns, or “fat tails,” as they are often called.
“We have just gone through a period of fat tail returns and investors are sensitized to the possibility,” Gordon Fowler, the president, CEO and chief investment officer of Glenmede, writes in the firm’s November investor letter Review & Outlook. As a result, he says, protection against extreme outcomes has shot up in price to levels he considers “unreasonable.”
Fowler says the protection often takes the form of long Treasury bonds, which “are pricing in Japanese-style deflation”; gold, which “is pricing in hyperinflation”; and the cost of equity portfolio protection, which “reflects a perceived probability of a 40% price decline within one year.”
Glenmede takes a different approach in creating a risk-controlled growth portfolio. “We find it can be beneficial to run counter to the fashion of the day,” Fowler writes.
He lays out seven recommendations for investing in the current environment:
- Lighten up on Treasuries and ultra-high-quality corporate bonds in favor of stocks.
- With a lighter position in high-quality bonds, we recommend finding less-expensive risk control.
- Our secured option strategy, which shorts call options against an index of stocks, is also an appropriate risk-controlled strategy in this environment.
- Global fixed income offers a more flexible approach that adjusts to market valuation levels.
- Equity managers who focus on stock picking are due to outperform.
- High-quality junk is still attractively priced relative to other fixed income assets.
- Invest in commodities instead of gold as an inflation hedge.
Fowler concludes this discussion with a lighter coda in which he explains why his communication with investors has fallen off to once a quarter in recent years.
Glenmede is an independent investment and wealth management firm with more than $18 billion in assets under management.