Insight

Time to rip up the asset allocation rulebook

By Danielle Levy (Citywire) – 5 February 2021

As 2021 begins, admittedly with more of a whimper than a bang, asset allocators find themselves at a difficult juncture: the Covid-19 pandemic has thrown our day-to-day lives upside down, resulting in unprecedented monetary and fiscal stimuli around the world. Investment committees across the UK face the challenge of assessing the potential fallout from Covid-19 on both markets and economies over the short and long term. As we find ourselves in uncharted territory, forecasting becomes even more difficult. ‘The historic risk and return of an asset can be observed, measured and modelled. That is easy,’ said Jim Wood-Smith, chief investment officer for private clients at Hawksmoor Investment Management. ‘What that does not tell anyone is what will happen in the future. ‘Past performance is used to guide guesses about the future, but that does not disguise that they are still guesses.’ Complicating matters further, it is becoming clear that what worked well over the past decade may not generate similar returns in the future. Equity and bond valuations are close to all-time highs, which gives investors much less to work with. It also raises concerns about the effectiveness of the traditional 60:40 model, which has formed the basis of many strategic asset allocation models for decades. Andrew Wilson, the chief investment officer at Lockhart Capital Management, acknowledged that the 60:40 model has served investors well over the past 20 years – as long as it included a healthy allocation to high-quality bonds, which do not tend to correlate with equities during a downturn. ‘It is not necessarily hugely sophisticated or diversified, but it works in an environment of falling interest rates and inflation, and continued to work last year,’ he said. ‘However, it is predicated on equities and government bonds staying negatively correlated.’ Given the elevated valuations of both equities and bonds, Wilson expects there will be changes to asset allocation models soon. ‘Portfolio managers are starting to consider what they will need in a world of rising inflation and interest rates, and if multiples on the equity market fall. Being long of expensive asset classes that no longer diversify each other is not that attractive a proposition.’ ‘Portfolio managers are starting to consider what they will need in a world of rising inflation and interest rates, and if multiples on the equity market fall. Being long of expensive asset classes that no longer diversify each other is not that attractive a proposition.’