Back to policy: Reallocating to risk assets in a risk-off market
Investment Director – Pensions, Strategic Client Solutions
Aberdeen Standard Investments
Investors are likely significantly underweight equity relative to their Investment Policy Statements (IPS) thanks to the financial fallout from the global coronavirus pandemic. As a result, either to realign with their IPSs or to pursue strong opportunities for growth, many investors may now be seeking to increase their allocations to “risk assets.” While this may be a prudent decision, investors may find rebalancing back to policy unsettling in this hyper-volatile environment.
At ASI, we believe institutional investors may to achieve their long-term investment goals in a way that confronts their fear and volatility concerns. To do this, the focus should be on seeking to optimize diversification among the five investment “buckets” defined below. In addition, investors should opportunistically seek out strategies that will maximize both performance within the category and for the portfolio as a whole.
Finding a custom, optimized solution
We believe the allocation to each of the buckets above should be based on a combination of qualitative reasoning, governance capabilities, long-term stochastic projections and short-term scenario analysis. Qualitative reasoning is a tool to identify high-conviction investment opportunities. Investors must also assess governance to confirm that the qualitative goals are attainable. Quantitative, long-term projections (based on both stochastic and scenario analyses) are crucial to verify future effectiveness after conditions stabilize.
In the face of near-term uncertainty, investors should emphasize scenario analysis, which considers overall portfolio return and risk in specific possible scenarios that may unfold over the next year:
- Will we have a U-shaped recovery?
- A reverse J-curve?
- Will the recovery take months or years?
- Will there be several peaks and troughs?
- Will we experience deflation or hyper-inflation?
Projecting yields, spreads, and overall returns under each scenario for a proposed portfolio will help investors understand the spectrum of potential results and decide on an appropriate rebalancing approach in the current environment.
What does the optimal set of results look like? The allocation among the options above likely depends on specific situations and investment objectives. At ASI, we believe investors should look to create and implement a customized strategy best-suited to these objectives that takes advantage of the current economic climate.
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