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All Asset All Access

All Asset All Access: Tactical Repositioning in a Changing Global Market

Research Affiliates discusses the increase in portfolio tactical shifts and recent research efforts supporting the All Asset strategies in today’s evolving investment environment.

Founder and chairman of Research Affiliates, Rob Arnott, and CIO Chris Brightman discuss portfolio positioning shifts in today’s evolving market conditions. Cam Harvey, partner and senior advisor of Research Affiliates, shares recent research efforts pertaining to the ongoing evolution of the All Asset strategies’ investment process. As always, their insights are in the context of the PIMCO All Asset and All Asset All Authority funds.

All Asset All Access is published quarterly.

Q: How has the positioning of the All Asset strategies evolved in this year’s market environment?

Arnott: When markets are quiescent, so are we; when markets are turbulent, we respond. Over the past few months, our portfolio shifts have been markedly dynamic. At the onset of the COVID-19 health crisis, the All Asset strategies were positioned defensively, as we discussed in our previous All Asset All Access. During the “take no prisoners” sell-off across global risk assets in the first quarter, we experienced two firsts – the fastest equity bear market from peak to trough in history and the highest spike in volatility – paired with even more tumult in other markets (oil briefly trading at $40 per barrel negative?!). (Sources are the S&P 500, the VIX, and WTI oil prices.)

As markets indiscriminately sold off during the “peak fear” months of March and April, we shifted into a more risk-on posture in the All Asset strategies. We trimmed our defensive positions and selectively rotated into what we saw as bargains with elevated multi-year return prospects, including EAFE stocks (Europe, Australasia, Far East), commodities, U.S. small-cap stocks, and REITs (real estate investment trusts).

The economist Ben Graham liked to distinguish a temporary loss of value from a permanent loss of capital: The former is a rebalancing opportunity; the latter is a disaster. Unfortunately, any bargain usually gets there for a reason: It looks to many like a risk of a permanent loss of capital, whether or not it really is. Bargain hunting usually means buying whatever is most out of favor – and whatever is out of favor generally has a reason it could continue to flounder. I’ve always believed that the right long-term strategy is to selectively and patiently buy what’s cheap. We believe haste is a mistake, because we’ll never catch the bottom price; whatever is newly cheap may very likely get cheaper before it turns. So value investing can be a deeply uncomfortable strategy before the market rebound. But, comfort is rarely rewarded, and never for very long.

Markets have now sharply recovered to pre-pandemic levels in most cases, fueled by aggressive quantitative easing measures, rate cuts, fiscal stimulus, and buoyant market sentiment. After re-risking following market declines, our strategies have shifted back to a more defensive stance as we look to take profits from resurgent risky assets, buy long bonds, and in the case of All Authority increase its U.S. short equity position. From the lows on 23 March 2020 through 31 July 2020, All Asset and All Authority have rebounded, delivering cumulative net-of-fee returns for the Institutional Class Shares of 23.40% and 24.41%, respectively.

Figure 1 is a table listing performance of the All Asset Fund and All Asset All Authority Fund, Institutional share class, net of fees, over various time periods through 30 June 2020 (quarter end) as well as 1-month performance as of 31 July 2020. Performance is shown for benchmark indices over the same time periods. Data is within the table, and important disclosures are written below the table. 

For the most recent quarter-end performance data for the All Asset and All Asset All Authority funds, please click on the links below:

The next round of stimulus may push riskier assets higher, but at a cost of even lower long-term prospective returns, and even higher risk of potential inflation (albeit not immediate) as the ultimate “solution” for addressing the monumental level of U.S. debt. Yet our research suggests that assets that hedge inflation are – with few exceptions – currently trading at deep discounts relative to mainstream stocks and bonds.

Q: What has led to the rise in tactical shifts within the All Asset strategies, and how have your long-term capital market expectations changed in these volatile markets?

Brightman: Volatility often creates opportunity. Accordingly, tactical shifts in our positioning correspond to market volatility. As cross-sectional asset class volatility increases, we tend to find more opportunities and consequently make more aggressive tactical shifts within the portfolio. Elevated volatility in the most recent quarter corresponds to an annualized portfolio turnover of 200% for All Asset and over 300% for All Authority (see Figure 2). These latest turnover levels are significantly higher than the average historical turnover levels of the strategies, which hover near 50% for All Asset and 75% for All Authority. Though let’s not forget that that the multi-year period prior to 2020 featured some of the lowest levels of market volatility ever (as measured by the CBOE VIX Volatility Index).

Figure 2 is a pair of scatter charts illustrating how portfolio turnover within the All Asset strategies rose in the second quarter of 2020 (relative to the long-term moving average since January 2016) with elevated cross-sectional asset class volatility. See notes and definitions written below the chart. The data for the All Asset Fund shows annualized one-way portfolio turnover of about 250% and annualized cross-sectional asset class volatility of about 15% as of 30 June 2020; asset class volatility was higher and turnover similar one month and two months prior. The data for the All Asset All Authority Fund shows annualized one-way portfolio turnover of about 300% and annualized cross-sectional asset class volatility of about 15% as of 30 June 2020; asset class volatility and turnover were both higher one month and two months prior. For comparison, for both funds over the longer term (since January 2016), the annualized 60-day moving average largely clustered in a range between 5% to 10% asset class volatility and 0% to 100% turnover. 

Following the broad market declines in the first quarter, our models forecasted a huge rise in expected returns; our long-term real return estimates for the equally weighted portfolio of diversifying asset classes we label Third Pillar[i] (real return, high yield bonds, emerging markets) doubled from 2% to 4% per annum. Then, during the second quarter, market prices snapped back. Our estimated real return for the S&P 500 fully reverted to its near-zero level pre-COVID. Yet, our estimated return for diversifiers remains well above its 2019 year-end level, at about 3% in July.

Q: What research efforts pertain to the ongoing evolution of the All Asset strategies’ investment process?

Harvey: Early in my career, I published a paper called “The Variation of Economic Risk Premiums.”[ii] The idea was simple. Certain sources of risk are persistent – and usually predictable. In the depths of a recession when markets have fallen, risk premiums tend to be higher. Of course, identifying persistent and predictable sources of risk are equally as important today.

Rob’s research has demonstrated that factors tend to exhibit momentum-like behavior. This information has proven useful in the creation of multi-factor equity strategies that dynamically adjust factor allocations. PIMCO offers these strategies, and we employ them in the All Asset funds.

Recently, Rob and Chris have overseen a new key research initiative: a suite of quantitative models that attempt to identify and exploit periods of persistence that are complementary to the All Asset funds’ existing tactical models and the underlying strategies already engaged in this endeavor. Two recent papers, “Momentum Turning Points"[iii] and “Breaking Bad Trends,”[iv] explore an important finding of this research initiative.

Many models apply a static momentum strategy, for example, a 12-month or 1-month lookback window to generate buy or sell short signals. The 12-month lookback (which we refer to as “slow”) may result in missing a price rebound or correction. In contrast, a 1-month lookback (which we refer to as “fast”) may increase the risk of whipsaw from price noise, believing a turning point has materialized when it has not. We find benefits in employing a dynamic weighting scheme across fast and slow signals, contingent on where we believe each asset is in its own market cycle.

The result, in our analysis, is that improved risk-adjusted return is possible relative to generation-one trend-following approaches, particularly in and around market turning points. Given that trend-following portfolios of all types (both fast and slow) tend to suffer around market turning points, and given turning points have tended to occur at higher frequencies over the last decade than they have in the past, we view this approach as uniquely applicable to navigating today’s evolving investment environment.

A second research initiative has reexamined how relative signal-level strategies operate. The standard implementation may be to overweight the assets with the highest signals and underweight those with the lowest signals. For example, with 15 assets we could have five overweights and five underweights. Alternatively, we can approach this type of strategy as a series of relative signal-level pair trades. For example, we could look at the 105 different pair strategies among 15 assets and select pairs with the best track records. The latter approach leads to different assets being selected with different weights on these assets and potentially to higher expected returns and lower drawdowns in the historical data.

These research projects, among others, are ongoing and promising. We are optimistic that the portfolio managers and the Asset Allocation team can apply these insights to the All Asset funds’ large (and growing) opportunity set of available exposures and incorporate them into the investment process.

The All Asset strategies represent a joint effort between PIMCO and Research Affiliates. PIMCO provides the broad range of underlying strategies – spanning global stocks, global bonds, commodities, real estate, and liquid alternative strategies – each actively managed to maximize potential alpha. Research Affiliates, an investment advisory firm founded in 2002 by Rob Arnott and a global leader in asset allocation, serves as the sub-advisor responsible for the asset allocation decisions. Research Affiliates uses their deep research focus to develop a series of value-oriented, contrarian models that determine the appropriate mix of underlying PIMCO strategies in seeking All Asset’s return and risk goals.

In this 5-minute audio clip, All Asset portfolio managers Rob Arnott and Chris Brightman discuss tactical positioning amid market stress (transcript also available).

CLICK TO LISTEN


[i] Third Pillar markets include REITs (real estate investment trusts), TIPS (U.S. Treasury Inflation-Protected Securities), high yield bonds, commodities, emerging market (EM) equities, and EM local bonds. The corresponding indices are FTSE Nareit All Equity REITs Index, Bloomberg Barclays U.S. TIPS Index, Bloomberg Barclays U.S. Corporate High-Yield Index, Bloomberg Commodity Index Total Return, and J.P. Morgan Government Bond Index-Emerging Markets (GBI-EM) index. Data is index based, does not reflect investment management fees, and returns would be lower if such fees were reflected. Return assumptions are for illustrative purposes only and are not a prediction or a projection of return. Return assumption is an estimate of what investments may earn on average over the long term. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods. Third Pillar portfolio data is provided for illustrative purposes and is not indicative of the past or future performance of any PIMCO product. Research Affiliates LLC capital market assumptions may vary from those of PIMCO.
[ii] Wayne E. Ferson and Campbell R. Harvey, “The Variation of Economic Risk Premiums,” Journal of Political Economy 99, no. 2 (April 1991): 385-415
[iii] Ashish Garg, Christian L. Goulding, Campbell R. Harvey, and Michele Mazzoleni, “Momentum Turning Points” (December 2019), SSRN no. 3489539
[iv] Ashish Garg, Christian L. Goulding, Campbell R. Harvey, and Michele Mazzoleni, “Breaking Bad Trends” (May 2020), SSRN no. 3594888
The Author

Robert Arnott

Founder and Chairman, Research Affiliates

Chris Brightman

Chief Executive Officer and Chief Investment Officer, Research Affiliates

Campbell Harvey

Senior Advisor, Research Affiliates

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