Consumer trust isn’t something to be taken for granted, but reports from the UK, US and here at home are all pointing towards an uplift in trust levels around financial advice, which can only be a welcome development.
There are significant tailwinds behind the financial advice industry at the moment, but some major obstacles are still preventing advice practices from taking advantage of surging demand according to a new study from CFS.
The death of the 40/60 is overstated
The 40/60, or balanced, portfolio has seen a growing stream of eulogies as “experts” the world over suggest it is broken.
The reason, they surmise, is the diversification-based investment approach relying too much on long-duration assets, and the threat of interest rate hikes seeing bond and equity market correlation move to one.
While there are clearly important points to consider, to eulogise the approach may well be overstepping the mark. Rather than throwing the baby out with the bathwater, I’ve put together four easily implementable “tactical” tilts that seek to overcome some of the major concerns raised by commentators.
The growth in passive investing cannot be understated: it has become a powerful force with many investors simply blaming the poor-quality performance of most active fund managers for their own demise. However, as recent years have shown, passive investing is not perfect, nor is it suited to every environment.
The first strategic tilt is to remove any passive exposure within fixed-income allocations; more specifically, to cut duration risk out of the portfolio. Passive investing ultimately favours the largest companies or governments in any market, and in the case of bonds, this means whoever has more debt gets more money from the index.
Despite suggestions of the opposite, central banks and governments are not patsies when it comes to issuing bonds and will always issue at the most opportune time. Hence the duration within the benchmark index has extended significantly as bond terms moved out as long as 30 years. The result is that these benchmarks are now more sensitive to interest rate hikes than ever.
The selloff in the technology sector has been vicious and fast, with non-profitable companies the worst-hit in the initial stages; and this may well only be the initial stages. Unfortunately, the major global indices are now dominated by the same technology companies, making it difficult to achieve an appropriate level of diversification. One option, in my view, is to seek diversification based on size.
Global smaller companies, similar to private markets, offer a significantly larger universe of investments for managers to consider, and as a result greater potential for outperformance. Whereas a large cap manager must make a relative decision on dominant holdings like Apple and Microsoft, a small-cap manager can be rewarded for going off the beaten track and finding the next CSL, Amazon or Facebook. Most importantly, smaller companies have for decades, and continue to, trade at a significant discount to their large-cap counterparts.
This may seem a little too contrarian, but the time is right to shift to Asia. After a significant sell-off in 2021, global equity managers have deserted the region, sending valuations down as much as 50 per cent. This despite China’s economy and the businesses within it continuing to grow at levels far exceeding their developed-market counterparts. While some suggest there are “air pockets” growing in US technology valuations, their Chinese alternatives have clearly been de-rated.
The region is now set to be supported by a loosening of monetary policy, and after pushing a COVID-zero policy across the northern winter may well see the same bounce as the developed economies enjoyed post-lockdowns in 2022.
Finally, after years in which we were punished for holding cash, perhaps it’s time to hold a little extra. But it must be earmarked for a purpose and be ready for deployment should volatility ensue.
