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TEXT ON SCREEN: John Cavalieri, Asset Alloocation Strategist
Cavalieri: Hi, I’m John Cavalieri, member of the asset allocation team here at PIMCO, joined by Rob Arnott, founder and chairman of Research Affiliates.
As you look ahead, what do you think are supportive macro or market factors that could support returns in the All Asset style of portfolio?
TEXT ON SCREEN: Rob Arnott, Founder and Chairman, Research Affiliates
Arnott: Well, there’s really three.
Text on screen: TITLE – Market factors that could support returns, BULLETS – Anchored inflation expectations, Cheap non-US currencies and markets, Value is cheap
One is that inflation expectations are still anchored, even as inflation itself has soared well above historic norms. The second is that non-U.S. currencies and markets are broadly much cheaper than U.S. markets, so international diversification represents a wonderful opportunity. And the third is that value is cheap, by some measures, cheaper than even at the peak of the tech bubble.
Cavalieri: Rob, could you talk about the role that All Asset can play in an investor’s portfolio as a diversifier?
Arnott: Absolutely. Diversification is one of the core tools at our disposal to tamp down the risk of our portfolios while we’re seeking incremental sources of return.
Now, diversifiers behave differently from classic 60-40 balanced investing. Most asset allocators anchor on 60-40.
Text on screen: TITLE – Home markets of All Asset, BULLETS – TIPS, Commodities, REITs, Emerging market stocks and bonds, High yield
All Asset is different. Its home markets are the diversifying markets, things like TIPS, commodities, REITs, emerging market stocks and bonds and high yield.
So instead of trying to predict when it’s going to be needed, we believe the sensible thing is to always have an allocation.
Cavalieri: And do Research Affiliates’ forward looking return expectations support that outlook today?
Arnott: Absolutely. With stocks priced at near record valuation multiples, the forward looking returns are likely to be anemic, perhaps even below the rate of inflation. Diversifiers have the advantage of having been out of favor over the course of the 2010s and currently priced to potentially give you return on a forward looking basis based on our long term return models than domestic stocks or bonds.
Diversifiers tend to respond very well to rising inflation expectations.
The thing that I think is most interesting is no one can predict with confidence which way inflation’s going to go, but if you’re paid in improved returns for buying an inflation hedge, why on earth wouldn’t you do it?
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The terms “cheap” and “rich” as used herein generally refer to a security or asset class that is deemed to be substantially under- or overpriced compared to both its historical average as well as to the investment manager’s future expectations. There is no guarantee of future results or that a security’s valuation will ensure a profit or protect against a loss.
It is not possible to invest in an unmanaged index.
Diversifier: The average return across TIPS, Commodities, REITs, HY, EM local bonds and EM equities. This serves as a simple and investable “home base” market proxy for All Asset.
60/40 balanced portfolio: A portfolio blend of 60% U.S. equities and 40% U.S. bonds, representative of a traditional, mainstream balanced portfolio structure.
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