Text on screen: PIMCO
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Text on screen: John Cavalieri, Asset Allocation Strategist
John Cavalieri: Rob, you've recently co-authored a piece titled, "Is Diversification Dead?” noting that the past decade’s returns for diversified portfolios have disappointed relative to mainstream US stocks and bonds. Can I ask you to summarize your findings, including answering the question, "Is Diversification Dead?”
Text on screen: Rob Arnott, Founder and Chairman, Research Affiliates
Rob Arnott: Is Diversification Dead? No, diversification is not dead. But, diversification can be a regret maximizing strategy.
During a roaring bull market for mainstream stocks, your classic diversified balance portfolio, typically 60 percent stocks, 40 percent bonds, has performed brilliantly. And alternative asset classes can’t keep pace.
FULL PAGE GRAPHIC: TITLE – Is diversification dead? A look by decade (diversifiers* vs. 60/40); SUBTITLE – Diversification cycles are driven by changing relative valuations; IMAGE – a bar graph depicting annualized real returns for 1973-1980, 1981-1990, 1991-2000, 2001-2010, and 2011-2020.
We went back over the last almost 50 years, to ask the question, what good is diversification? Back in 1974, the stock market was low and bond yields were high. Today, the stock market is high and bond yields are low. So it’s been a great 48 years for a classic 60/40 balance portfolio.
It would be very dangerous to assume that the 2020s will look like a continuation of the last decade, for the very simple reason that yields tumbled, and stock valuation multiples soared to create the great returns of the 2010s. And if you expect that again in the 2020s, you're expecting valuation multiples to soar to new highs, new all-time highs, and yields to fall from already low levels.
John Cavalieri: Chris, what does Research Affiliates’ analysis suggest are likely to be the best returning markets over the next five to 10 years?
TEXT ON SCREEN: Chris Brightman, Chief Investment Officer, Research Affiliates
Chris Brightman: Looking forward from today’s elevated prices,
FULL PAGE GRAPHIC: TITLE – Research Affiliates’ current long-term return estimates (nominal); SUBTITLE – Long-term nominal return estimates for major asset classes; IMAGE – A graph shows the spread of long-term nominal expected returns vs volatility. A callout states that around 3% forecasted annual return difference for diversifiers
we forecast a return for the US equity market of 2 percent over the coming decade. Long treasuries with a trailing 10-year return of 8 percent for the past decade, are now priced at 0 to negative real yields, which is about what you can expect they will provide over the next decade. Cheaper assets, notably including emerging market equities, which have seen trailing 10-year annualized returns of a mere 5 percent, offer a more attractive return forecast of 8 percent annualized over the coming decade. Putting together a portfolio of domestic stocks and bonds, we forecast nominal returns of approximately 2 percent per annum over the coming decade. On the other hand, an efficient frontier portfolio with similar risk as US 60/40 is priced to deliver nominal returns of 5 percent over the coming decade. How? This efficient portfolio has outsized exposures to much more cheaply priced diversifiers, inflation-sensitive assets, and non-US markets.
John Cavalieri: Rob, can you talk about the outlook for value-oriented equity strategies at this point in the cycle?
Rob Arnott: If you use the classic definition of value, price-to-book value, the performance of value relative to growth was terrific for the 43 years from 1963 to 2007.
FULL PAGE GRAPHIC: TITLE – Global Value Premium; IMAGE -- a line graph shows relative valuation (ratio of value P/B to growth P/B) over the years from 1997 to 2020.
And then subsequently, has underperformed. That’s a 13 and a half year dry spell. 13 and a half years from the last peak to the trough last August. We find that value underperformed not because the value companies were doing badly in their underlying business, but they weren’t doing worse than historic norms.
We come to the conclusion that,
IMAGE: Rob Arnott in the forum, trade floor
over the coming five years, we're expecting potentially double digit excess returns for value relative to growth. Now, it’s for this reason that All Asset’s strategies have traded into all-time high exposure to the PIMCO RAE strategies in the last quarter, mostly outside the US, because US stocks are expensive, and non-US stocks aren’t. So, these strategies are currently positioned to further amplify any rebound in value in the years ahead. And we do think that that rebound started last September, and is likely to continue for several years.
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TEXT ON SCREEN: PIMCO, 1971-2021, 50
Please note that the following contains the opinions of the manager as of the date noted, and may not have been updated to reflect real time market developments. All opinions are subject to change without notice.
Past performance is not a guarantee or a reliable indicator of future results.
All investments contain risk and may lose value. The strategy invests in other PIMCO products and performance is subject to underlying investment weightings which will vary. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee there is no assurance that private guarantors will meet their obligations. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. The cost of investing in the strategy will generally be higher than the cost of investing in a strategy that invests directly in individual stocks and bonds. Diversification does not ensure against loss
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