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What if things go wrong? Building resilient portfolios

02 April 2019

Alastair Greenlees, Senior Investment Strategist at Kempen believes that while there are several ways to protect portfolios, traditional defensive strategies may not be the answer. In addition, by looking strategically at different asset classes investors can build in resilience by taking advantage of opportunities that arise, even in challenging markets.

Trump, China, Brexit, and the ending of QE have dominated the financial headlines over the past six months. They have created uncertainty. There are warning signs everywhere that the coming months are going to be tricky to navigate.

Take that one day in January when Apple shares fell by more than 9%, over concerns about slowing Chinese growth. That 9% represents roughly the entire value of Lockheed Martin or Goldman Sachs (or pretty much any individual company in the FTSE 100).

The bull market is close to a record ten-year run, and as each day passes the likelihood grows of it turning into a bear. Investors fear a large and sudden crash, however here at Kempen we believe that investors should be equally wary of a slow death caused by gradually deflating asset prices over a longer-period. This ‘death by a thousand cuts’ can be equally detrimental to a portfolio in the long run.

Most investors broadly have a simple challenge:

  1. The need to generate (absolute and/or relative) returns and thus a need to take risk – this prevents them simply selling out of every risky asset they own and buying safe-haven assets.
  2. Operating within defined risk parameters – they can’t ‘bet it all on black’.

With Kempen’s expectation that market returns are likely to be lower in the future the two obvious routes to creating a more robust portfolio that can survive the inevitable buffeting are diversification and safe-haven assets.  

  1. Diversification suffers as a protection strategy from Black swan events (e.g. 2008) – where all risk-bearing asset classes (supposedly uncorrelated) became highly correlated and fell in value at the same time.
  2. It also suffers from ‘Diworsification’ – the real diversification benefit of a new asset or mandate start to fall significantly after there are already 10 (or so) other mandates / assets.

    Safe haven assets (e.g. gold, Swiss Franc) returns are typically too low returning and are not all safe in all crises.

Balance is key in all portfolios. We cover a number of different investment approaches in detail which may be attractive opportunities at the current time. In Summary:

Equities

Moving to Value stocks may not provide the defensive positioning hoped for – a focus on quality and margin of safety is important.

Real Estate Investment Trusts (REITS) may prove an interesting diversifier within an equity portfolio, although would need to be aware of an investor’s other allocations to property.

Small-cap equities may be less exposed to geopolitical risk factors and, historically, have benefitted from a size premium, providing the investor has a longer time period (3 years or greater).

Global Equity Income has a natural level of diversification and offers a broader income generation base than UK Equity Income.

Credit

Credit spreads have risen, making them more attractive, however the duration attached to ‘traditional’ credit / high yield investments presents a risk.

Low duration private credit such as CLOs, CMBS and ABS are interesting (particularly as an alternative to high yield credit given the yield pick-up from structured credits over similarly rated high yield).

Alternatives

We see value in private equity in the small/mid-market space (vs larger leveraged buy-outs).

Infrastructure, agriculture and timberland all currently present interesting investment cases for investors seeking a long time-horizon investment with diversification benefits to the rest of the portfolio.

With markets becoming ever-more unpredictable, it’s important for investors to take a broad view of their portfolio and perhaps think slightly differently about how to prepare themselves for the turbulence ahead.

Read the full report What if things go wrong? Building resilient portfolios; exploiting opportunities here

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2019, 02 April

What if things go wrong?

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Alastair Greenlees

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