How to survive in Pamplona

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Please note that this article may contain technical language. For this reason, it is not recommended to readers without professional investment experience.

Just like the Saint Fermin Pamplona bull run, financial markets can arouse fear and excitement. Broadly diversified, multi-asset investments are in our view one of the best options for investors looking to survive in the face of a bemusing array of GDP growth uncertainties, swings in macroeconomic data, geopolitical fears and market volatility that has now stabilised at levels close to the long-term average (see below).

Exhibit 1: VIX index (Chicago Board Options Exchange SPX Volatility index)

volatility index

Source. Bloomberg as at 7 March 2016

In current financial markets, characterised by a declining influence of external stimulus, we can be more confident that “bad will be bad” and “good will be good” when it comes to news or data. This is a welcome development seeing how in the past “bad appeared good” given the uncertain environment brought about by central banks’ unconventional monetary policy.

In a “winner takes all” market, at first glance, performance will be the only parameter that investors take note of, with no distinction between the thousands of management styles populating this type of multi-asset investments still sustained by strong inflows across Europe.

Multi-asset investments can efficiently capture market risk premiums

Since the end of 2014, we at THEAM believe asset allocation flexibility has become paramount to limit drawdowns and turn market challenges into opportunities. Investment performance can come from the asset manager’s ability to efficiently capture market risk premiums.

To accomplish this, six years ago THEAM built a strategy where the weightings allocated to the various asset classes are not set in stone and there are no guidelines favouring one asset class over another. At no time do these strategies hold just one asset class or focus, say, 60%, of the portfolio exposure on a single investment theme. Instead, funds are always invested in a range of assets and the mix is adjusted according to the short-term realised volatility of each asset held in the portfolio.

Multi-asset investments: aligning with market dynamics

Today, this is known as an unconstrained strategy, where cross-asset volatility helps to align a flexible asset allocation with market dynamics. A key objective and benefit of this approach is to minimise losses in a downturn and maximise returns when markets are rising. This asymmetry can meet the needs of investors who, in an environment that has become structurally more volatile, are looking for a strategy that seeks to provide a stable risk profile without sacrificing the potential return.

Our ‘Isovol’ risk-based strategic asset allocation is designed to offer risk stability and exposure reactiveness in bull and bear markets. Medium-term opportunistic ‘diversification assets’ aim to contextualise the portfolio within a dynamically changing world. The aim of such opportunistic trades could be to hedge the portfolio against a growth slowdown, e.g. in China (by being long Australian 10-year government bond), and an unstable market environment (by being long gold). Being long the US dollar index should allow the strategy to benefit from gains in the dollar against G4 currencies.

Riding the bull and grabbing it by the horns

Tactically, the fund manager may put in place hedging strategies to manage the market inflection points he identifies, even before a rebalancing signal has been activated. By combining the strengths of our asset managers and calculation models, the strategy has outperformed the market peer group since the end of 2009. (Please note that past performance is no guantee of future results.)

So not only can we ‘ride the bull’ as we adjusting the composition of our multi-asset investments according to market direction, but we can also ‘grab the bull by its horns’, maintaining our ‘speed’ over time. It’s a bit like imagining you are at the Saint Fermin Pamplona Bull Run and managing the situation rather than letting events override you.

Written in Paris on 3 March 2016.

Migel /

Andrea Mossetto

Senior Investment Specialist, THEAM

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