Asset Allocation

By now, the situation is clear. Many economies are gradually slowing down or have already entered a recession (think European powerhouse “Germany”). A recession affecting even the ‘greatest’ economy of them all is probably right in front of us. As a result, how investors position their portfolios this coming quarter and in 2020 may be all that matters.

Central banks can’t save major developed nations from entering recession. You only need to listen to central bank policy makers to hear them now effectively admitting that they’re pushing on a string. They don’t control economic growth, and are effectively begging other arms of (seemingly deaf) governments to rethink their policies, provide fiscal stimulus and structurally reform.

Central bank policy has prolonged the inevitable but has only really been effective at creating an “Everything Bubble”, which has made many of those with mainstream assets richer (at least on paper, and quite possibly temporarily without further action!). The “Everything Bubble” has been built off the back of too much debt - which is totally unsustainable - and an economy which is far too small to support current asset prices without massive and perpetual interventions. There is an almost universal belief in a fictitious world of ever increasing prosperity, despite obvious political and policy madness and badness. Most current government policy is simply highly central bank dependent and aimed purely at elevating asset prices and stopping broader economies from collapsing in an overly financialised world.

By perpetually applying crisis-like stimulus, great distortions and inefficiencies in capital allocation have occurred. These include vast numbers of listed and unlisted ‘zombie’ companies just waiting to destroy the wealth of ‘zombie’ index investors, distorted and elevated housing markets, and outrageous unlisted valuations including venture capital “Ponzi” investing schemes valued as multibillion dollar ‘unicorns’. There is a great price that has to be paid for all of this.

Slowly but surely, we are now seeing signs of economic and market strain as the global economic and financial system wilts under the strain of reality. Simply trying to encourage people to borrow more money through cheap debt is butting up against the reality of a future which many can now recognise as simply unsustainable. While money is cheap, the proletariat class can’t afford to borrow and spend more given their income prospects, and what the wealthy can buy with cheap money is already overpriced and hence unattractive. Governments could be taking advantage of long term cheap money to fund real economic growth and pro-growth initiatives, but have chosen to largely sit on their hands for now.

Somewhat amazingly, no one has yet seemingly told many equity and property markets that there is a recession and crisis coming soon, and that equities and property tend to suffer large falls when there is a recession! That said, many of these markets have largely gone nowhere for some time, held up by perpetual central bank interventions. Perhaps then, the best investors can realistically hope for is these markets continue to oscillate but stay elevated for a long time because of continuing easy money, rather than imminently collapse to correspond with real economic prospects. However, unfortunately, history seems to suggest a crisis is more likely than a range trading market, and that central banks will ultimately prove impotent. It is easy to understand why most investors would completely lose confidence in our fictitious economies and asset prices if they truly understood them, and this is cause for great concern. Try to remember that change comes slowly, but then all at once.

It is of course very important to understand that to be wealthy, you have to stay wealthy; that means surviving and protecting capital through adverse economic and financial market conditions. In fact, it is simple mathematics that large negative returns destroy long term compounded returns, and hence large losses should be avoided at all costs. Effectively, the size of ones’ gains in bull markets are far less important than avoiding large losses in bear markets. This is the reason why Rule no 1 is always “Don’t lose money”. In this context, it is easy to understand why given the market and economic conditions now is such an attractive time to look for an alternative approach.

Where then to invest when there is an everything bubble? Asset prices being almost uniformly too high have led many successful high net worth investors to build up cash, and wait patiently for what they see as the “inevitable” falls that have come in every cycle before this one. This could work if markets do indeed collapse imminently. But what if prices simply stay static, offering no opportunity to ever deploy the cash prospectively? In this case, gradually all traditional asset classes including cash will simply suffer years of no effective return.

Is there then an option to preserve wealth and yet still target positive absolute returns regardless of what happens to markets? Indeed, there is. One can benefit from both capital preservation and more prospective returns than cash through investing dynamically, selectively, and skilfully in absolute return managers whose return streams are not market dependent. Simply put, if the market is ripe for a fall or years of low returns, simply avoid and minimise this risk by investing in unrelated skill-based returns which offer many of the benefits of cash, but with much better return prospects than cash. In this way, investors can win either way – they can make money regardless of whether markets continue to defy gravity, yet they can also protect capital if equity markets collapse.

Of course, implementation of such an approach requires significant effort and skill, and is genuinely a strategy that investors are best using skilled fund managers to implement. Such approaches are not widely available, or even widely understood as an option - and hence can’t be used by all investors. Most investors will always be fooled by strong past returns and low interest rates into buying more overpriced assets at the end of a cycle through “low cost” (high price!) index strategies, or borrowing cheaply to buy more overpriced property. After all, most investors think that there is no alternative to losing money in a recession or bear market. But there is an obvious alternative – and that is using genuine alternatives! This alternative path can and should protect your capital from large losses and adverse market conditions, yet – unlike cash – offers strong prospects of an attractive return stream as well as long as it is skilfully implemented.

In summary and simply put, if traditional markets are ripe for a fall or years of low returns, simply avoid the risk by investing in genuine non-market dependent and liquid alternatives. This can be done skilfully and carefully and in a diversified and hence safer way by experienced investment professionals running a dynamically managed multi-asset fund of fund type approach. In this way, investors can make money if markets continue to defy gravity, and they can protect capital if equity markets collapse. Investors can also better target the absolute return streams many of them are looking for.



Comments

Please sign in to comment on this wire.

Peter Brown

An insightful article. You write: This alternative path can and should protect your capital from large losses and adverse market conditions, yet – unlike cash – offers strong prospects of an attractive return stream as well as long as it is skilfully implemented. This can be done skilfully and carefully and in a diversified and hence safer way by experienced investment professionals running a dynamically managed multi-asset fund of fund type approach. Other than your own firm, which I presume offers ordinary people like myself the opportunity to do this, what other funds do so. Can you provide ANY examples.? The utility of the article would increase significantly if people had some idea of what funds actually do what you are suggesting.

Harry

Good to read some common sense logic although very belated. I have my own ideas where to invest but because of technology now totally controlling the financial markets which allows governments unfettered control over the citizens savings it will be a very challenging time.

Dr Jerome Lander

Hi Peter Thanks for your interest. The Lucerne Alternative Investments Fund is a unit trust offered by Lucerne Investment Partners, and Dynamic Asset's Wealth Protector portfolio is a managed account for goals based advisers and their clients. By way of example, both of these went up in August when equity markets fell. There is little else in Australia that I am aware of which is diversified and similarly managed. Indeed, it is difficult to find diversified options which are likely to perform well over a full cycle including a recession and bear market, and most investment products are heavily market dependent. There are also individual manager strategies such as the Harvest Lane Absolute Return fund, which can form part of a more diversified portfolio. I'd suggest you speak to an adviser about the suitability of any investment to your own needs and preferences, before investing.

Douglas Schorr

Hi Peter Brown, you clearly understood something of this article ... I'm lost. What is 'This alternative path'? Thanks.

John Dakin

We are to assume, I suppose, that Dr Lander and Procapital will offer this "skilful", "dynamically managed" solution to the challenges we face as investors in the current climate. Unfortunately, there is little evidence to support such an assumption, at least in this article...

Graeme Holbeach

".... by experienced investment professionals running a dynamically managed multi-asset fund of fund type approach" sounds all too familiar. Those around in the early to mid 2000s may recall the launching of a number of this type of fund. A quick flick through the bottom drawer of the filing cabinet found Colonial Global Diversified Strategies, HFA Diversified Investments, GS/JBW Retail Multi Strategy and Deutsche Strategic Value. Despite all four being touted to make money in both rising and falling markets, none did. The average draw-down of this group during the GFC was roughly 35%. Only the HFA product, with a different promoter, survives. Will this approach work in the next bear market? History says no, but there are enough weird things happening these days that, maybe this time, things really will be different.

Noddy Smith

Another condescending and useless article from Dr Jerome. He explains that everyone in the world is stupid (except himself) and seems to believe that he's the only person to have heard of absolute return strategies. Once again he offers no practical advice or investment ideas despite giving his article the title of "How to invest productively...".

Ben Edwards

Feels like one big sales pitch to me.

Craig

I haven't learned anything from reading this article...Is this "skillful" approach investing in 'Put' options and Bear ETF's? What are these "exceptional risk adjusted returns absolute returns" net, after fees? The whole article just reads as sales spin to me. Am I missing something?

Dr Jerome Lander

Hi Graeme - I would make the point that genuine active strategies aren't all the same and can't be easily grouped together! Furthermore, as Head of Research, I actually reviewed many of those strategies you have mentioned pre-GFC. Interestingly, we gave them poor ratings at the time. They are not all the same! Furthermore, the multi-asset fund I started and actually ran during the GFC period had a very different and positive return outcome. I believe I would still be running it if the institution hadn't have sold the business. Hi "Noddy" - Can I suggest that if you continually don't like reading my articles - or anyone else's - you simply stop reading them? There are many livewire readers who enjoy reading my articles, which are very well viewed and liked. Hi Craig and others - I am happy to speak to you or any reader personally if you would like to engage with me directly to answer your questions in great detail.

Noddy Smith

There's a few important points to note about the author's response to Peter's request for alternate investment examples "Other than your own firm". Jerome names the Lucerne Alternative Investments Fund and Dynamic Asset's Wealth Protector portfolio before declaring that it's difficult to find anything else. Note that Lucerne is a "Fund of Funds" so investors are paying a manager to select a group of funds, so there will be two levels of management fees deducted. Also, Jerome has forgotten to disclose that he is the manager of this fund. The second example given - well, unfortunately Jerome has failed to mention that he is also the manager of this product.

Dr Jerome Lander

"Noddy" - You appear to me to be operating under a fake name. False and personal attacks are unwelcome.