Photograph of Robert Arnott, Founder and Chairman, Research Affiliates
Rob Arnott: What we've seen is a take no prisoners market crash. Anything with a whiff of risk cratered in February and March. Anything with a whiff of illiquidity cratered. And really the only thing that went up materially was long treasury bonds. A classic flight to safety. Have we ever seen anything like that before? September to November of 2008.
The All Asset funds, both All Asset and All Authority were in a moderate overall risk position. We'd been increasing our defensive allocations as our models indicated generally full valuations, and increasing probabilities of an economic slowdown.
Now Covid-19 had an element of surprise, but we were cognizant of downside risks emphasizing diversification with a strong value orientation.
To the extent that we were having any risk on posture, that was focused in emerging market stocks and local currency emerging markets debt and to a much smaller extent in international developed equities.
And when we saw a take no prisoners crash in 2008, it was followed by a sorting out process in which the market then looked around at the carnage and asked the question, what got hit to implausibly cheap levels.
There are opportunities in volatility. Look for the alpha associated with a drawdown when you have illiquidity driven fear to snap back and give you a potential positive gain.
Volatility can be our friend, if you're willing to look past the volatility and ask which markets are savaged beyond recognition, and which markets are even post-crash still not cheap. You can actively reposition the portfolio.
There's three things that can help us, on top of the already substantial yield of the assets that we're invested in. What if inflation expectations recover? Do we really think they're going to stay low for a prolonged period over the coming decade? What about foreign currency as a flight to safety has been superb for US assets and for the dollar relative to foreign currencies. And what about the cheapness of value. What about the potential added alpha associated with the RAE strategies and their current deep value tilts.
We think the time to buy is when you're at peak fear. And my observation on March 17 was we're in a period of peak fear. This is a time to begin averaging in to buying, to begin averaging in to moving a little bit more risk into the portfolio.
So the opportunity for a value snapback, for a snapback in foreign currencies, for a snapback in breakeven inflation rates, in inflation expectations, each of these could give us a handsome tailwind even if the other two don't kick in. If all three of them happen, then you have three tailwinds at once.
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