Asset class boundaries have blurred and that means investors may need to take a different approach to asset allocation, a Unigestion report suggests.
“Through a combination of the falling quality of sovereign bonds and the forced diversification of their fixed income bucket, investors have made their fixed income allocation more equity-like,” writes Patrick Fenal,
deputy chairman of Unigestion. “This is far from reassuring! It’s probably the exact opposite of true diversification.”
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He says alternatives are a fantastic concept, but quantitative easing has killed off volatility and most long-volatility strategies, which has led investors to favour equity-related strategies instead.
At the same time, equities have become more complex. The ultra-low-yield environment and the search for return has resulted in some parts of the equity universe becoming a substitute for fixed income, and more likely to react negatively if rates increase sharply.
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“In short, equities are becoming more like fixed income, and fixed income like equities,” Fenal says.
What choices do investor have? Not much, other than factors.
“Factors don’t care if the data series relates to convertible bonds or equities; they will spot the moving force behind the series,” he explains. “The bad news is that client constraints, regulation and investment processes will have to evolve for us to be able to use them in place of the old system combining bonds and stocks.”
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While factors are not a panacea, Fenal says their relationships are not stable over time and their definitions are still to be standardised, but they provide a useful level of diversification.
“Factor investing is not a cheap option,” he notes, “but it represents a fascinating new dimension in how to measure and respond to risks.”