The financial services industry “needs to rethink portfolio construction,” says Sébastian Page, head of global multi-asset at T. Rowe Price.
Speaking at the firm’s virtual global market outlook briefing, Page explained why such a change is necessary now, recounting major market developments over the past year, many due to the impact of the COVID-19 pandemic. Here are some of the highlights of his presentation.
1. The Failure of Diversification
Recalling the close correlation between U.S. stocks and different asset classes during the late February to late March market selloff, including foreign stocks (both developed and emerging market), U.S. investment-grade and high-yield corporate bonds and real estate, Page said, “We can expect diversification will continue to fall when we need it the most. … Diversification tends to work best on the upside and very bad when you actually need it on the downside. It is a flawed concept.”
Page is not suggesting that investors don’t diversify their assets but that they add to the mix of assets since Treasurys “will no longer be as effective a diversifier for stocks” with interest rates near zero.
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He recommends long-duration bonds, which still have some hedging properties because yields remain higher at the long end of the yield curve and they could possibly appreciate in price. In addition, he likes absolute return assets such as liquid alternatives that allow investors to take long and short positions; active management that dynamically manages risks; gold, which can trade like a risk asset in the short run but can be a hedge in longer run; and low-interest currencies like the Japanese yen.
Even with these alternatives, however, Page, author of a new book, Beyond Diversification, said investors “have to recognize the new reality we’re in,” and take more risk to reach a certain expected rate of return or lower their return expectations if they don’t.
2. 60/40? More like 80/20
One example of taking more risk to get an expected level of return is to increase the allocation to stocks. T. Rowe Price multi-asset team estimates that “to get a 6% expected rate of return going forward you’re going essentially to need to hold more stocks than ever before … depending on assumption and asset classes perhaps as much as 80% stocks,” Page said.