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Diversification Rewarded Investors in Q2: Natixis

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The most broadly diversified investment portfolios performed best in the second quarter, Natixis Global Asset Management reported Wednesday.

Use of alternative strategies, which reached a three-year high in the second quarter, helped boost diversification levels, the report said.

“The trends we’re seeing suggest the return of more traditional market dynamics, where investors are rewarded with enhanced returns for taking diversified risks,” John Hailer, chief executive of Natixis Global Asset Management for the Americas and Asia, said in a statement.

“Prior to the third quarter of 2015, investors generally were taking on more risk to achieve higher returns, and many got hurt when the recent sharp, episodic bouts of volatility hit the markets.”

In the second quarter, average moderate-risk model portfolios analyzed by Natixis grew by 2.1%, outpacing the average retail portfolio’s gain of 0.5%. By comparison, the S&P 500 gained 2.5%.

Although moderate model portfolios had limited exposure to high-yield bonds and international stocks, their strong relative performance benefited from a diverse mix of alternative strategies and fixed-income investments.

Managed futures, gold, market-neutral strategies and long-duration government bonds were the biggest drivers of diversification in the second quarter.

Natixis reported that U.S. advisors continued to favor domestic stocks over international ones, with equity concentration contributing to 92% of overall portfolio risk.

However, when volatility accelerated last August, investment professionals began to allocate more of their client assets to alternatives and to a wider variety of alternative strategies within the allocation. For the most diversified portfolios, this helped lessen the severity of equity market drawdowns over the past year.

In June, Natixis reported that volatility had prompted many investors to diversify their portfolios in the first quarter.

According to the new report, portfolios that were well positioned ahead of plunging oil prices and global growth concerns earlier this year and the June 23 Brexit vote responded better to those market shocks than ones that diversified reactively or sporadically.

From the market peak on Aug. 18, 2015, through June 30, returns by the most diversified, best-performing portfolios in the top quartile grew by 2.7%, exceeding the bottom quartile by 340 basis points.

“Diversification matters,” Marina Gross, executive vice president of Natixis’ Portfolio Research and Consulting Group, said in the statement.

“In an environment distinctly lacking in precedent and visibility, diversification may be one of the best defenses an asset allocator has.”

The second quarter Natixis Portfolio Clarity Trends Report tracked the asset allocations and performance of 347 moderate model portfolios submitted by U.S. financial advisors to its consultant team for review from January through June. These were among a broader sample of 2,290 portfolios submitted in the January 2013 to June 2016 period.

The report is designed to track professional investor behavior trends over time.  The retail investor average portfolio is a benchmark constructed from 50,000 retail investor portfolios.

Allocation Trends

The Natixis analysis showed that the average moderate-risk portfolio had 52.7% of assets in stocks in the second quarter, down from 54.8% for the same period in 2015.

The average allocation to U.S. equities was 35%, compared with 14% for international equities.

Natixis said the high concentration of domestic equities reflected the S&P 500’s strong relative performance in recent years, and was in part due to a lack of attractive opportunities in other asset classes.

Bond allocations, which had bottomed out in 2015 on the prospect of higher interest rates, ticked up 3% in the second quarter, to 30% from 27% of holdings. Exposure to intermediate-term bonds rose to 11%, or about 36% of the typical bond portfolio, in the expectation that interest rates would remain low. Municipal bonds of all types accounted for 8% of fixed-income allocations.

Allocations to alternatives increased to an average of 8% across all portfolios, two percentage points higher than at the end of the 2015 second quarter. The average weight was 11% for the two-thirds of portfolios that invested in alternatives funds.

Five percent of the portfolios were in allocation funds, and the remaining allocations were split among cash, real estate investment trusts and commodities.

Natixis found that the best-performing portfolios in the top quartile of those it analyzed had several factors in common. For one, they had lower allocations to equity: 45% in the top quartile vs. 62% in bottom quartile.

In addition, they had 33% allocations to fixed income and 11% to alternatives, compared with 24% and 5% for the bottom quartile.

The top-quartile portfolios allocated much more to intermediate-term bonds and managed futures than ones in the bottom quartile.

Finally, the best performers enjoyed “diversification benefits” of 25%, a measure of the percentage of risk diversified away because of low correlations between holdings.

The diversification benefit among top quartile portfolios was some 10 percentage points higher than among the bottom quartile portfolios.

Natixis said that in order for diversification to have the biggest effect, it should be broadened across both a variety of asset classes and geographic regions, currencies, investment strategies and more traditional economic, market and style risk factors.

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