- Consider redesigning your portfolio or thinking beyond the traditional 60/40 allocation.
- Seek growth opportunities resulting from the accelerated trends caused by Covid-19.
- Barbell your bonds (for both yield and liquidity): pair higher yielding instruments with broader “core” bond exposures, which could help mitigate risk.
Like so many others, I begin 2021 with a mixture of anxiety, caution and optimism. And the first couple weeks of the year have validated all of these emotions. I know from my conversations with financial advisors around the country that I am not alone. We are facing a social, political, and market environment unlike anything we’ve seen in my 30 years of working in this industry, while trying to help advisors help their clients meet their goals. Questions abound: Are we truly seeing the possibility of a return to normalcy? Covid-19 cases are up, new strains of the virus are appearing, but the vaccines offer hope that the end is in sight. Can the economy continue to rebound? How do I build or adapt investor portfolios for this environment? Will political unrest and uncertainty find balance and calm?
To help investors navigate the uncertainty, the BlackRock Investment Institute (BII) recently published its 2021 outlook. An overarching theme was how the Covid-19 pandemic has accelerated shifts already occurring in our economy. In other words, trends such as a shift to online retail or the growth of sustainable investing are likely to be with us even after the pandemic has subsided – which has important implications for portfolio construction. As Armando Senra discussed in his outlook implementation guide, there are three areas we should consider when making portfolio decisions in 2021:
1. The new nominal. BII sees stronger economic growth ahead, but coupled with stable nominal yields, even though the path to a full economic restart is potentially bumpy. The narrow Democratic sweep with victories in the Georgia senate elections means “the new nominal” theme may even speed up, with the potential for more stimulus, higher inflation, less likelihood of major immediate tax increases, but continued low interest rates.
2. Globalization rewired. A geopolitical shift was happening even before Covid-19, with trade conflicts on the rise, and a remaking of global supply chains. I spoke before about the deglobalization improving the diversification benefits of international and emerging investing, and the pandemic has further accelerated this transformation.
3. Doing well by doing good, and portfolio specialization. The pandemic has accelerated pre-existing trends like the shift to sustainable investing, and megatrends like exponential technologies and new healthcare advances. All of this means, advisors are smart to look beyond the traditional 60/40 portfolio of stocks and bonds and consider new areas of potential growth.
The takeaway from these insights is not new: investors need to be positioned for both short- and long-term opportunities as well as the risks. But how we capitalize on opportunities and how we incorporate long term risks such as climate change may impact how we build portfolios. It is time to rethink and redesign those portfolios, I believe.
Against that backdrop, how should advisors consider incorporating these insights into their clients’ portfolios? Here are three ideas to consider:
First, consider portfolio redesign, or thinking beyond the traditional 60/40 allocation. With stock volatility and valuations elevated, bonds are less equipped to provide protection. That means it might be a good time to consider multi-asset strategies. It also means that investors should consider, as mentioned earlier, increasing diversification with international equities. According to our most recent survey of advisor portfolios, U.S. stocks make up 75% of the average total stock allocation. Moreover, much of those stock positions may be concentrated in the so-called FAANGM stocks (Facebook, Amazon, Apple, Netflix and Alphabet), which now account for 22% of the 10 largest index or active mutual funds, up from 10% in 2015. Even within your U.S. equity position, this could represent heightened risk.1
Second, consider growth opportunities stemming from the accelerated trends resulting from the pandemic. Two areas in particular stand out. First, we have seen an increased focus on and flows into sustainable investing. More and more clients are demanding it, and as I wrote last year, it is supported by a compelling investment case. Second, are megatrends. Covid has accelerated megatrends already in place such as technology – think online retail, or work from home technologies – and healthcare, specifically genomics and immunology, critical to the fight against Covid and other diseases.
Finally, barbell your bonds (for both yield and liquidity). The low yield environment appears to be with us for some time, with central banks keeping interest rates low, while demand for bonds remains high. Investors are faced with a dilemma: take on more risk or accept lower income. One solution is to barbell: pair higher yielding instruments, such as high yield and emerging market bonds with broader “core” bond exposures, which can potentially help mitigate risk. Alternatively, one can combine core exposures using an ETF with mutual funds that can potentially offer outperformance. But watch that those mutual funds are not simply hugging the benchmark with higher fees. You can even consider your bond portfolio as a pyramid with three layers: One seeking income with credit and high yield, one seeking capital preservation with low duration and flexible strategies and the base focused on equity diversification with core bonds, investment grade and longer duration. Each of those layers in turn can be barbelled, either for additional liquidity (mixing private or relatively illiquid bonds with a highly liquid core bond ETF) or to attempt to gain additional yield.
A final note: As I’ve written in the past, tax implications and the potential impact of fees on performance are more important than ever to focus on. Tax implications of the funds in a portfolio are far too often overlooked, and while it seems unlikely that we will see a huge tax increase, it is important to try to create a more tax-efficient portfolio.
Every advisor understands the importance of having both a plan and the right tools to implement that plan. The best strategy — especially this year — is to “hope for the best, prepare for the worst” as the old adage goes. The good news is that iShares ETFs can provide low cost efficient investment tools to help prepare you for either situation.
Originally Posted on January 22, 2021 – Financial Advisors’ Guide To 2021
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1 Source: Bloomberg as of 12/31/2020.
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