Diversify, Different
Embracing New Sources Of Return Through Multi-Asset Investing
I
n today’s low yield environment, traditional approaches to asset allocation may fail to provide
adequate returns and may not protect investor
portfolios in critical phases. The need to build
more genuinely diversified portfolios is essential to
enhance returns and protect against excessive drawdowns. In essence, a new approach to multi-asset investing is needed.
To us, this means moving from traditional asset
class diversification to a focus on risk. We call this
approach “Diversify, different’’ - identifying the risk
factors that fundamentally drive asset classes returns, and measuring and combining them in an effective way.
It also means not only maximising the sources of
beta diversification and managing them in a dynamic
way, but also promoting a culture of alpha generation
that tries to exploit all possible alpha sources to enhance returns in a risk conscious framework.
INVESTORS ARE FACING NEW CHALLENGES
During the 80s and 90s, investors enjoyed mostly benign market conditions, and asset allocation was a
relatively simple task. Events played out differently as
the 2008 global financial crisis erupted, with liquidity
and volatility issues emerging.
In the aftermath of the financial crisis, largely expansive monetary policies and unprecedented quantitative easing experiments created a very different
investment environment, characterised by low nominal rates and negative real rates.
By looking at the past, we see that phases of financial market turmoil have proven challenging for
traditional asset allocation portfolios. During periods
of pronounced market stress, portfolios traditionally
diversified by asset classes suffered substantial losses, as multiple asset classes experienced simultaneous
drawdowns, despite a history of muted correlations.
This, in our view, calls for an urgent change of
direction from traditional asset allocation, to one
that focusses deliberately on allocating the different
sources of risk, instead of a simple allocation to different asset classes.
we believe it is important to construct portfolios that
are well diversified among these risks, and to continuously monitor overall risk exposure.
In doing so, we believe it’s important to analyse
which risk factors most impact the overall portfolio
and which dynamics could influence these risk factors going forward. This analysis requires a clear
picture of the macroeconomic scenario and financial
market conditions.
We have identified three main factors that we expect will drive risk dynamics over the next several
years: low inflation, a stronger US Dollar and Federal
Reserve interest rate policy.
ALPHA AND BETA WORKING TOGETHER
The second element of the ‘Diversify, different’ approach is the focus on both the alpha and beta components of returns, with the aim of enhancing returns in
a low yield environment. On the beta side, this means
to utilise opportunistically all appropriate sources of
diversification. On the alpha side, we need to understand the main elements driving alpha and how we
can act on them. Alpha is essentially a function of the
number of independent investment ideas and a port-
We believe that in this
new world, it’s time to
“diversify, different”.
folio manager’s skill. We combine this with another
key element, the behavioural aspect of investing. One
of the most important skills in portfolio management
is timing the entry and exit of positions, as this will
have a big impact on the win/loss ratio. As the world
is experiencing uneven economic growth, specific dynamics at the country/industry/sector levels become
extremely important. Divergences in economic conditions and asset class or sector valuations may provide
significant opportunities to generate pure alpha.
ALLOCATING RISK
DON’T UNDERESTIMATE TAIL RISKS
In order to build a more robust portfolio, we believe it
is important to identify the key factors underpinning
portfolio risk, and to ensure that the portfolio is effectively diversified among these factors. Each asset
class is exposed to different risk factors. The sensitivity of the asset classes to risk factors and the risk factors themselves change over time and under different
circumstances, so it is important to adopt a dynamic
approach, relying in part on macro research, in order
to interpret the complexity of the system.
Once the major risk factors have been identified,
Finally, recent crises have taught investors the importance of protecting portfolios from extreme ‘tail risks’,
as these events can be highly damaging to the overall
portfolio.
We believe that an effective approach to this task
should be based on 3 steps:
I. Identify tail risks based on alternative macroeconomic scenarios
II. Analyse the possible impact on the portfolio of the
tail events (stress test)
III. Identify possible hedges to protect from tail risks
DISCLAIMER
Unless otherwise stated all information and views expressed are those of Pioneer Investments as at 8 May 2015.These views are subject to change
at any time based on market and other conditions and there can be no assurances that countries, markets or sectors will perform as expected.
Investments involve certain risks, including political and currency risks. Investment return and principal value may go down as well as up and could
result in the loss of all capital invested.
Pioneer Investments is a trading name of the Pioneer Global Asset Management S.p.A. group of companies.
Matteo Germano
Global Head of MultiAsset Investments,
Pioneer Investments
To manage extreme events, it is important to analyse the alternative scenarios that could drive significant portfolio losses and identify their probability of
occurring. A stress test analysis can then be conducted to scope the extent of losses under extreme circumstances for the overall portfolio, as well as for individual asset classes and positions. This can enable an
assessment of the most efficient way to help protect
the portfolio from extreme losses. Today, there are
multiple hedging techniques available to help protect against tail risks, thanks to the development of
the derivatives markets. In general, the opportunity
to implement these techniques should be assessed
based on the stress test results, while also taking into
account the cost of hedging.
A REALITY CHECK
After many years of bull markets, investors will likely
have to deal with a more volatile world, making the
need for protection and capital preservation even
more urgent.
“Diversifying, different” aims to build more robust and diversified portfolios, using low correlated
strategies. In the effort to achieve this, it is important
to understand the main macro themes and, using
portfolio management skill, identify the most compelling investment ideas, while attempting to keep
risk at reasonable levels.
The Multi-Asset team has evolved its approach
to seek to enhance diversified alpha generation,
diligently identify potential risks, and address alternative scenarios with hedging strategies. We have
worked extensively along these guidelines and designed a multi-asset investment process that searches
for effective diversification both in the alpha and beta
fields. We believe defining a clear world view while
hedging the principal risks, and seeking to maximise alpha opportunities from relative value, are at the
forefront of the process and can help clients navigate
today’s market challenges.
In our opinion, a well-designed, multi-strategy investment approach will be instrumental in the years
to come in managing the new complexity in a way
that provides efficient investment solutions to clients.
In short, we believe it’s time to Diversify, Different.