Investment Insight | Be patient, trust the process
Low interest rates are creating challenges for investors who have relied on bonds to serve two purposes in a portfolio: first, as a source of steady income, and second, as a source of protection in periods of volatility.
In the past, bonds have provided positive returns during bear markets, but during the COVID-19 market collapse, when interest rates were already low, the returns on bonds were also low.
When interest rates are low, increasing a portfolio’s allocation to shares to boost returns is tempting. It would require the acceptance of considerably higher risk, especially given the valuation of shares is well above average. Accepting greater risk may be uncomfortable for investors with shorter-term savings objectives or lower risk tolerances.
In our view, investors should instead maintain an exposure to shares and bonds but supplement this with other asset classes.
Is the 60/40 portfolio dead?
The challenge for investors is how to rethink the traditional 60/40 portfolio (60% growth assets and 40% income assets), and specifically how to maintain diversification. We believe bonds and shares still have a critical role to play in portfolios, but strategies require a global reach and must be liquid and flexible enough to reflect the investment regime. Why? Because bonds and shares alone are not going to generate the returns investors have become accustomed to over the past 10 years.
We wrote on 22 April 2021 | Investment Insight that most New Zealand asset managers and KiwiSaver providers are limited in the kinds of assets they can invest in – usually shares, bonds and cash. We are not limited by asset class. As a result, we can seek out opportunities wherever they may be. This means we can invest in currencies, commodities, cryptocurrencies, futures contracts and options, alongside the traditional building blocks of our clients’ portfolios – shares and bonds.
Current market view
There will be times, like we are experiencing this month, when markets are volatile and there is no clear market direction. During these times, clients’ portfolios may underperform. But the performance we hope to generate for clients is not linear and negative months are part of the journey in building wealth.
In fact, monthly performance is short-term thinking. The investment regime is complex and volatile, and it will take longer than a month or two for us to witness our thesis on rising and sustained inflation, rising commodity prices and increasing interest rates to play out. Until then, we continue to underwrite our views which are being driven by record government and central bank stimulus, successful vaccine development and, up until now, record low interest rates.
Be patient and trust the process
A mentor of mine reminded me in the third quarter last year to be patient and trust the process. Sage advice. The results for 2020 subsequently spoke for themselves. Looking forward, we are excited that over the next 12 to 18 months client portfolios are positioned to generate strong returns no matter how global share markets behave.
The global economy is embarking on a huge structural change, especially in bond markets where for the first time in over 10 years we will witness sustained inflation and interest rate rises. We just have to be patient.
In the past, bonds have provided positive returns during bear markets, but during the COVID-19 market collapse, when interest rates were already low, the returns on bonds were also low.
When interest rates are low, increasing a portfolio’s allocation to shares to boost returns is tempting. It would require the acceptance of considerably higher risk, especially given the valuation of shares is well above average. Accepting greater risk may be uncomfortable for investors with shorter-term savings objectives or lower risk tolerances.
In our view, investors should instead maintain an exposure to shares and bonds but supplement this with other asset classes.
Is the 60/40 portfolio dead?
The challenge for investors is how to rethink the traditional 60/40 portfolio (60% growth assets and 40% income assets), and specifically how to maintain diversification. We believe bonds and shares still have a critical role to play in portfolios, but strategies require a global reach and must be liquid and flexible enough to reflect the investment regime. Why? Because bonds and shares alone are not going to generate the returns investors have become accustomed to over the past 10 years.
We wrote on 22 April 2021 | Investment Insight that most New Zealand asset managers and KiwiSaver providers are limited in the kinds of assets they can invest in – usually shares, bonds and cash. We are not limited by asset class. As a result, we can seek out opportunities wherever they may be. This means we can invest in currencies, commodities, cryptocurrencies, futures contracts and options, alongside the traditional building blocks of our clients’ portfolios – shares and bonds.
Current market view
There will be times, like we are experiencing this month, when markets are volatile and there is no clear market direction. During these times, clients’ portfolios may underperform. But the performance we hope to generate for clients is not linear and negative months are part of the journey in building wealth.
In fact, monthly performance is short-term thinking. The investment regime is complex and volatile, and it will take longer than a month or two for us to witness our thesis on rising and sustained inflation, rising commodity prices and increasing interest rates to play out. Until then, we continue to underwrite our views which are being driven by record government and central bank stimulus, successful vaccine development and, up until now, record low interest rates.
Be patient and trust the process
A mentor of mine reminded me in the third quarter last year to be patient and trust the process. Sage advice. The results for 2020 subsequently spoke for themselves. Looking forward, we are excited that over the next 12 to 18 months client portfolios are positioned to generate strong returns no matter how global share markets behave.
The global economy is embarking on a huge structural change, especially in bond markets where for the first time in over 10 years we will witness sustained inflation and interest rate rises. We just have to be patient.
Source: Bloomberg, NZ Funds research.
Source: Bloomberg, NZ Funds research. Price to earnings ratio.
Source: Bloomberg, NZ Funds research. Prices are indicative and based on a 10 year constant maturity bond.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
For more information please contact NZ Funds.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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