Is portfolio diversification, at least as traditionally practiced, a chimera?
Sébastien Page, head of global multi-asset at T. Rowe Price, said as much during a press briefing hosted this week by his asset management company.
The press briefing featured several T. Rowe Price investment strategists and portfolio managers discoursing on a range of topics. Page’s presentation covered a variegated landscape based on the top five charts he believes will matter for the markets over the next year.
One of those charts dealt with diversification across different stock, bond and real estate indexes. Page showed that, as in other major crises, correlations jumped and diversification failed during the depths of the Covid crisis earlier this year.
“The problem is diversification tends to work well when you don’t want it on the upside, and [performs] very badly when you actually need it on the downside,” he said. He added that with interest rates near the zero bound, shorter-term Treasurys aren't an effective diversifier versus stocks.
“But if the search for yield and return continues to push investors toward risk assets, and assuming they’re willing to accept the shorter-term volatility, diversification will become even more important,” Page said.
He proposed improving portfolio diversification by expanding the mix to include options such as long-dated Treasurys, absolute-return investing, hedging, and other diversifiers such as foreign exchange, gold and "perhaps" investment-grade bonds.
His basic take is that traditional 60/40 portfolios allocated 60% to stocks and 40% to bonds need enhancements, and that investors can modernize portfolios with risk-aware strategies.
“Our industry needs to rethink portfolio construction,” Page stated.
Pandemic
Elsewhere in his presentation, Page said the ongoing pandemic will weigh heavily on the markets—in ways both good and bad—for the foreseeable future. That was illustrated by last week’s big jump in U.S. equities after Pfizer announced very encouraging data from its coronavirus vaccine trial with its German partner BioNTech.
“The pandemic will perhaps continue to be the most important theme driving the economy and markets for the next six to 18 months,” he remarked. “In that context, as asset allocators we no longer start our discussion with the usual question: 'Risk on or risk off?' Now we add a second question: 'Covid on or Covid off?'"
He offered that likely beneficiaries in a Covid-on environment include growth stocks, large caps and technology companies.
“In Covid-off, we begin to see a potentially fast, great rotation in favor of the more typical economic recovery trade favoring small caps, value stocks, credit and so on,” he said.
Ultimately, Page said, the economy will accelerate after we get through the pandemic, and that progress in vaccine developments is key to moving to a Covid-off world.