Three Resolutions for a Happy and Healthy Portfolio
In January, many of us turn our thoughts to New Year’s resolutions. Running more; eating less meat; picking up a better hobby: all decisions grounded in an understanding that our entrenched behaviors have room for improvement and a hope that motivation – and a bit of hard work – will turn our aspirations into positive outcomes.
This year, we decided to subject our investment processes to the same scrutiny as our eating and exercise habits.
As with most resolutions, our three 2019 investment resolutions begin with some reflection on what we have been doing so far, an acknowledgement that things may need to change, and a commitment to turning our aspirations into concrete actions.
The first thing we need to accept is that investors have been lucky – and some of us maybe even a little naughty – in our fixed income allocations. Central bank actions since the Global Financial Crisis have pushed down interest rates across almost all fixed income markets. During this period, generally the greater the risk (whether in terms of duration or credit), the better the returns.
But it’s time for change, because those great returns are now the equivalent of your tighter jeans. Interest rates and credit spreads are unlikely to continue to fall, so investors who have taken higher levels of credit and duration risk need to ask themselves whether it’s worth maintaining those positions. What is the fixed income part of the portfolio supposed to be doing? It can’t be to generate returns, as that’s what the equity allocation is supposed to do. What happens if risk assets sell off, and the fixed income allocation loses a substantial amount because it is loaded with risk-seeking – rather than risk-offsetting – positions?
So, for our New Year’s resolution number one: investors should be honest with themselves about what they’re trying to achieve in their fixed income allocation and adjust it accordingly.
The second thing to consider is that, while we inhabit a far more globalised world than that of even a decade ago, we continue to invest as if each region in the world is an island. Should we overweight Japan and underweight the US this year, for instance? In the past, we could compare what the US market was pricing in about the US economy to what the Japanese market was pricing in about the Japanese economy, and then make a choice about Japan versus the US accordingly.
Things have changed, however. Just as we should probably accept we can’t subsist on a diet of cheese and chocolate indefinitely, so too do we need to accept that in a world of global supply chains, geographically diverse corporate structures and international businesses, the benefits of a regional approach to investing may have peaked. If a company is registered in New York, manufactures its wares in Brazil, assembles them in South Africa and then sells them to Chinese consumers, which region are you actually investing in?
In today’s global economy, global investing simply makes more sense than regional investing. Though the shift will take time to reflect in investment processes, it is our second New Year’s resolution.
Our final reflection concerns currency hedging. Because low and stable interest rates have framed the global investment environment in recent years, currencies have been ignored by investors, who could instead focus on the underlying equity or fixed income markets. But now, some central banks now hiking, others are pausing, and a handful are even cutting rates.
In a world of diverging interest rates, our third resolution for investors is to start taking currency hedging seriously. (This one is particularly important for investors within the UK, where the currency is very reactive to the outcome of Brexit discussions.)
Three New Year’s resolutions to consider in 2019. Hopefully – unlike our half-hearted commitments to running 10K races and cutting out bacon rolls – these ones lead to real change. At the very least, we hope they prompt some thinking about whether some common investment practices are sustainable or if 2019 is the year for a better approach.
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