December, 2016 Print
Asbjørn Trolle Hansen, Head of Multi-Assets, Nordea Investment Management.
Making major asset allocation decisions based on macro calls of well-analysed events has recently proved to be a difficult strategy. Asbjørn Trolle Hansen of Nordea Investment Management outlines the importance of delivering a portfolio that offers true diversification
Macro event risk is always evident in markets. Investors have faced numerous such matters in recent times – for example unconventional monetary policy actions, currency interventions, bailouts and elections. Although these moments can have significant near-term impacts on markets, it is an extremely risky strategy to try to position a portfolio in anticipation of any single scenario.
This was clearly demonstrated during the recent UK referendum and the US elections. In the case of UK, many investors witnessed sharp downside after incorrectly positioning portfolios for a “Remain” vote which they had widely anticipated. In the case of the US election, many investors were caught out by Trump’s victory, which appeared unlikely until the last minutes. What was even more striking were the expectations of the markets in the event of a Trump victory – a difficult scenario for markets and sentiment. While markets first reacted negatively, they soon rebounded on hopes and speculation that Trump may be able to stimulate the US economy. Those investors who took up a defensive position at that time have been badly hurt.
Unfortunately, Brexit and the US election were not isolated incidents. The last 18 months have been rife with volatility and event risk. This was clearly on show during the summer of 2015 – which was highlighted by the fears surrounding Greece, and the China hard landing scare. The severe risk-aversion in markets, due to additional concerns surrounding China in January this year was another challenging period for investors. Once again, many participants within the DGF universe could not provide the much-needed – and often-promised – diversification for capital protection.
Similar to Brexit, Grexit or US election, there are a number of other risks on the horizon. To name a few: the consequences of the “No” to the Italian referendum, and the French and German elections in 2017 which could lead to other unforeseen events. Still, many investors will be unable to avoid the temptation to position in favour of an expected result. However, as was witnessed with the UK referendum and US election, this is a dangerous game to play – as polls and bookmakers alike, can often be wrong. In our opinion, investors simply do not need to take this risk. Rather, it seems that on average, making those directional calls and positioning portfolios based on no informational advantage relative to “all the others” in the long run is leading nowhere.
The Multi Assets Team at Nordea decided a decade ago to shift the investment focus away from asset class investing – such as top down or directional/beta investments. Instead, the approach is more bottom-up and we focus on return drivers, or risk premia, which are combined by relying on risk-balancing principles.
One of the primary reasons for this important distinction is that most asset classes can include several risk premia exhibiting significantly different characteristics over time, and separating these provides the opportunity to run a much more robust correlation analysis. This can help navigate periods of severe market dislocation – such as we witnessed during the period following the unexpected Brexit result. Diversification does not always occur immediately, but by building a truly diversified portfolio by combining similar amounts of risk between growth (beta) and conservative (anti-beta) return drivers, we can be less dependent on making the right macro call. Instead, we prefer to focus on generating capital preservation for investors and offer an all-weather strategy over a three-year horizon.
Volatility and event risk have always been and will continue to be a feature of investment markets. We believe the role of multi-asset managers and DGFs is to deliver a portfolio providing true diversification. This is not simply about piling into numerous asset classes or selecting the right asset classes which will outperform, but rather the identification of a select number truly uncorrelated positions able to deliver for investors through most market environments.