What if we get a slow-growth, weaker earnings economy in the second half of the year? Or what if it’s higher growth and higher prosperity? Either way, standing still may be the riskiest move.
The very things that have made diversified investing so rewarding in 2016 could be its undoing. So far this year, diversified strategies have benefited from the power of bonds to offset losses in equities. Also, some of 2015’s most problematic assets have performed better than almost anything else in 2016. But despite good performance so far, there may be risk ahead for diversified strategies—exposure to interest rates has been an effective portfolio stabilizer, but with rates having been so low for so long that may no longer hold true.
Consider two possible scenarios, the first being slow growth, weaker earnings and lower inflation. In that environment, risk assets could do poorly, but bonds would offer weaker diversification than they did in the first half of the year. Rather than waiting for diversification to stabilize the portfolio, we might be better served reducing our holdings of risk assets.
IFrame The second scenario is a higher growth, higher prosperity environment where risk assets could do very well. World equity markets, which have been flat for almost three years, could break out to the upside. But if that were to happen, we could see bonds repriced back to levels that create negative returns. In that case, we might prefer a more concentrated and risk-oriented diversification strategy.
Diversification has proven its long-term value, and sticking with a balanced asset allocation strategy is usually a great idea. But investors should resist the urge to become complacent in their diversification strategy. Sometimes, it can be very helpful to incorporate a dynamic or an adaptive element to your asset allocation strategy. This is one of those times.
Jeffrey L. Knight is the global head of investment solutions and co-head of global asset allocation at Columbia Management Investment Advisers LLC.