Global Investment Strategy
April 27, 2015 (Weekly Update)
Chris Haverland, CFA®, Global Asset Allocation Strategist
Weekly market insights from the Global Investment Strategy team
- Individual asset-class returns can be volatile from year to year. Therefore, investors should consider a diversified portfolio approach with exposure to the four major asset groups (Fixed Income, Equities, Real Assets, and Alternative Strategies).
- Employing a diversified portfolio of assets can often mitigate potential risks and help investors meet their long-term financial goals.
What it may mean for investors
- Review and rebalance asset allocations on a regular basis to make sure your portfolio is in line with your risk tolerance and long-term financial goals.
Time to Reassess Your Asset Allocation?
It is now 42 months and counting since the last S&P 500 Index correction (defined as a drop in the index price of at least 10 percent). Should you be worried? Not if your portfolio is properly diversified and regularly rebalanced back to strategic targets. History tells us there likely will always be a correction on the horizon. What we can’t predict accurately is when it will occur or what will trigger it. So, instead of worrying about the timing of these elusive events, why not proactively position your portfolio to absorb a potential shock to the equity markets?
Chart 1: S&P 500 Index Periods without a 10-Percent Correction
Source: FactSet, 4/23/15
There are specific reasons why we advocate diversifying portfolios into the four major asset groups—Fixed Income, Equities, Real Assets and Alternative Strategies. Obviously, the main driver is low correlations among each category (meaning that when one zigs another zags). But our views on asset allocation go beyond diversification benefits. We believe each asset class plays a vital role in addressing an investor’s desire to mitigate risks and meet long-term financial goals. Some examples include:
- Catastrophic events (cash, high quality bonds, commodities, and hedge funds): Events that radically change the landscape and create extreme distress in the global capital markets.
- Inflation (equities, real estate investment trusts or REITs, commodities, and Treasury inflation protected securities or TIPS): Inflation is one of the most corrosive forces that detract from long-term wealth. If we assume inflation averages 3.0 percent over the long term, investors would lose half the value of their assets in 25 years. Portfolios should be invested in assets that appreciate with inflation.
- Volatility (bonds and hedge funds): Make sure there is an allocation to assets that are designed to help stabilize the portfolio during periods of volatility, while remaining economically engaged.
- Liquidity (high-quality bonds and equities): Appropriate liquidity requires owning assets that can be productive in the portfolio and also can be converted to cash quickly when needs change. Changing needs can include new investment opportunities or an unexpected family situation that requires funds.
- Income (bonds, large/mid-cap equities, and REITs): Predictable cash flow that can be used for consumption or philanthropic distribution or any other needs.
- Growth potential (equities, REITs, and private equity): Employing assets that may outpace inflation and grow enough to address long-term financial goals.
Although we prefer equities at this point in the market cycle for several reasons including growth potential, inflation protection, liquidity, and in some cases their ability to generate income through dividend yields, it still makes sense to remain diversified in bonds, real assets, and alternative strategies, to generate additional income and to mitigate the potential impact of catastrophic events, unexpected volatility, and inflation.
Even in an uptrending stock market, bonds, real assets, and alternative strategies, can produce positive absolute returns. These same asset groups can help limit downside exposure when equity markets experience a correction. While the S&P 500 Index has outperformed many asset classes over the past few years, so far in 2015 it has lagged most asset class returns, which is one reason why we advocate diversification. In a nice demonstration of the value of diversification, many of the major asset classes we employ offset U.S. equity weakness in the first quarter, including international equities, REITs, hedge funds, and nearly all the fixed-income asset classes.
Despite today's low-yield environment, we continue to recommend some exposure to bonds to cushion potential equity declines and provide liquidity for rebalancing. With the sizeable gains in U.S. large-cap equities over the past several years and impressive performance of international equities this year, portfolios may be overexposed to risky assets. Setting and sticking to a disciplined rebalancing schedule should keep your allocations in line with your risk tolerance and long-term goals.
We cannot predict the timing of the next equity market correction, but realize it could come from an overheating geopolitical situation, a misstep in Federal Reserve policy, or an unexpected spike in inflation. Although we believe stock market corrections are healthy and inevitable, there have been long periods in the past without a 10 percent selloff (1984-1987, 1990-1997, and 2003-2007). Trying to time this event would be a futile exercise; therefore, we believe the best way to prepare for it is through proper portfolio diversification and rebalancing.
Chris Haverland is a global asset allocation strategist for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Haverland is responsible for thought leadership on the economy, financial markets, investment strategy, and asset allocation. He researches timely investment topics and produces market updates, special reports, white papers, podcasts, and webcasts that articulate strategies for clients that help them meet their long-term financial goals. Other responsibilities include developing capital market assumptions and strategic asset allocations, providing tactical advice, conducting asset class research, assisting in portfolio management, writing commentary for investment publications, and providing investment guidance for financial advisors and clients.
Prior to joining Wells Fargo, Mr. Haverland was a portfolio manager, corporate bond analyst and trader at Jefferson Pilot Financial (now part of Lincoln Financial) in Greensboro, North Carolina, where he managed $2.6 billion in fixed income assets. He has nearly 20 years of experience in financial services.
Mr. Haverland earned a Masters of Business Administration from Elon University and a Bachelor of Science in Business Administration from Appalachian State University. He is a CFA® charterholder and is a member of the CFA North Carolina Society. Mr. Haverland is located in Winston Salem, North Carolina.
*As of Sept. 30, 2014
All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity. Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investments in fixed-income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, also known as junk bonds, which have lower ratings and are subject to greater volatility. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.
There are special risks associated with an investment in real estate, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.
Alternative investments, such as Hedge Funds, are not suitable for all investors. Any offer to purchase or sell a specific hedge fund will be made by the product's official offering documents. Investors could lose all or a substantial amount of their investments in these products. Hedge Funds are only available to persons who are "accredited investors" or "qualified purchasers" within the meaning of U.S. securities laws. Hedge funds are not required to provide investors with periodic pricing or valuation and are not subject to the same regulatory requirements as other investment products. Hedge funds trade in diverse complex strategies that are affected in different ways and at different times by changing market conditions. Strategies may, at times, be out of market favor for considerable periods with adverse consequences. An investment in a hedge fund involves the risks inherent in an investment in securities, as well as specific risks associated with limited liquidity, the use of leverage, short sales, options, futures, derivative instruments, investments in non-U.S. securities, "junk" bonds and illiquid investments.
S&P 500 Index is a market capitalization-weighted index composed of 500 widely held common stocks that is generally considered representative of the US stock market. The Index is unmanaged and not available for direct investment.
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