For press use only
Column
Fed’s hike decision means investors
must look even harder for diversifying
assets
19 January 2017 | Author: Stan Verhoeven, Lead Portfolio Manager, NN (L) Multi-Asset Factor Opportunities at NN
Investment Partners
With the Federal Reserve starting to tighten monetary policy at a time when equities are touching alltime highs, investors will have challenging times ahead. How can investors improve diversification
within their portfolio and meet their long term objectives in this environment?
The need for diversification beyond equities and bonds is not new. For example, the traditional 60/40 portfolio
(stocks/bonds) showed a particular lack of diversification during the 2000-2002 market slump. Such a portfolio
proved to be dominated by equity risk, so what seemed to be a conservative approach was anything but that.
In the years following 2002, investors sought diversification benefits by adding allocations to so-called alternative
asset classes such as hedge funds, real estate and private equity. However, the evidence showed that more assets
does not necessarily equal more diversification. Correlations rose sharply during the crisis in 2008, not least
because hedge funds, private equity and real estate all carry significant equity risk. Furthermore, hedge funds
claimed to offer alpha but most of their performance can be attributed to a combination of traditional beta and
factors but then at high fees and a general lack of both liquidity and transparency.
To better diversify risk investors therefore need to identify other drivers of return that display positive
performance over time and low, even negative, correlations with traditional investments. We believe factor
investing across multiple asset classes offers this.
Much academic research has been published in recent decades that show the existence of factors and their
attractive and diversifying returns. The existence of factors can be explained by three distinct drivers:
I.
II.
III.
Compensation for risks that other investors want or need to transfer
Behavioural biases of investors causing assets to be “mispriced”
Compensation for providing liquidity in case of a supply and demand imbalance
By having a detailed understanding of these fundamental elements that drive returns, one can develop smart
investment rules that capture these attractive sources of returns.
We expect factors to continue to have positive expected returns going forward as the above-mentioned drivers are
not likely to evaporate. This is due to the fact that investors always want to be compensated for taking a risk,
human behavior generally does not change and investors’ objectives and restrictions will continue to generate
supply and demand imbalances.
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Academia has identified a plethora of factors, many of which are unlikely to generate attractive returns after
taking transaction costs into account. To avoid these, a robust investment process needs to be applied that
identifies and applies true factors that are supported by a strong economic rationale and can deliver positive
expected returns after costs in the long run. The five factors that we believe are present across asset classes are:
1.
2.
3.
4.
5.
Momentum: performance tends to persist, hence we go long the winners and short the losers.
Value: benefits from perceived incorrect valuations, hence we go long undervalued assets and short
overvalued assets.
Carry: benefits from the tendency that instruments with higher yields outperform those with lower yields,
hence we go long the instruments with a high yield and short those with a low yield.
Flow: markets are subject to predictable and excessive buying and selling pressures in the short term,
hence we go long excessive supply and short excessive demand.
Volatility: implied volatilities are generally higher than realised volatilities because implied volatility is a
compensation, not an expectation, of volatility. We pay realised volatility and receive implied volatility.
Beyond attractive return potential factors have a low correlation with traditional asset classes and with each other.
1
For the above mentioned Multi Asset factors, these correlations range from 28% to -13% . This low correlation
makes them very suitable for generating positive returns in all market circumstances.
Moving away from the traditional 60/40 approach and taking more account of the ‘factors’ involved in assets can
2
certainly yield benefits. Our own analysis shows that over the 11 years to end-April 2016, a 60/40 mix portfolio
returned an annualised return of 5.4% with a volatility of 10.6%. This compares with 6.2% and 9.5% respectively
for a portfolio that also allocates to factors. Aside from the enhanced returns, diversification benefits are also
shown in terms of a lower maximum drawdown, which is decreased by almost 4%.
To summarise, factor investing offers a robust, long-term solution for investors, especially in the current
environment. Given their low correlation and positive expected returns, they are a great addition to investment
portfolios.
ENDS
1
Total Returns, April 2005 – September 2016, excluding transaction costs. Comparison of portfolio with 60% MSCI World and 40% Barclays
Global Aggregate, rebalanced monthly versus a factor portfolio containing 54% MSCI World (NDDUWI), 36% Bloomberg Barclays Global
Aggregate Bond Index (LEGATRUU) and 10% Multi Asset Multi Factor Portfolio. The “Combined Model Portfolio & MAFO” represent a
constructed time series up to March 31, 2016. After that date, the gross of fees performance of NN (L) Multi Asset Factor Opportunities is
used. The period prior to April 2016 has been constructed using existing model portfolios created by NN IP. These model portfolios have not
been backfilled. Reported returns are based on our own calculations and, if applicable, assumptions, gross of fees and did not take into account
any transaction costs. Past performance is not indicative of future results. Source: NN IP, Bloomberg
2
Source: NN IP, weekly data, April 2005 to September 2016
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Press contacts:
Caroline Wroblewski
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+31 70 378 1281
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+31 6 30485111
E
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Marlie Zuidgeest
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About NN Investment Partners
NN Investment Partners is the asset manager of NN Group N.V., a
publicly traded company listed on Euronext Amsterdam. NN
Investment Partners is head-quartered in The Hague, the
Netherlands. NN Investment Partners in aggregate manages
approximately EUR 199 bln* (USD 224 bln*) in assets for institutions
and individual investors worldwide. NN Investment Partners
employs over 1,100 staff and is active in 15 countries across Europe,
U.S., Latin America, Asia and Middle East.
NN Investment Partners is part of NN Group N.V., a publicly traded
corporation.
* Figures as of 30 September 2016