Years of financial turmoil – and the promise of more to come – have forced investors to question traditional approaches to asset allocation, finds a new report from the Economist Intelligence Unit (EIU). ‘The Search for Growth: Rethinking Asset Allocation’, written by the EIU and sponsored by BNY Mellon, explores the development of key trends in asset allocation and risk management.
- Diversifying into non-traditional assets can lead to liquidity problems. Investors have been diversifying portfolios into non-traditional asset classes to boost returns and reduce risk. But investments they are turning to – such as emerging market stocks and bonds, commodities and currencies – are often inherently illiquid and expose portfolios to additional risk. Investing in these asset classes through exchange-traded funds (ETFs) isn’t always a solution, because ETFs can turn illiquid during periods of market stress.
- Investors are paying more attention to scenario testing. Investors are spending more time testing how portfolios respond under different macroeconomic scenarios. The goal is to make sure allocations can withstand market shocks and prosper in different points in the macroeconomic cycle. This so-called ‘regime-based’ approach to asset allocation may allow investors to find growth in uncertain times.
- Attitudes toward dynamic asset allocation strategies remain mixed. In response to today’s ‘risk-on/risk off’ market, a growing number of investors are advocating a more tactical approach by adjusting allocations dynamically in response to market movements. Although advocates believe the approach allows them to pick up more transient opportunities, others point out that dynamic strategies also tend to rack up transaction fees and can lead to sub-par returns.
- Passive investing has its own set of risks. Passive products, such as index funds, have grown steadily in popularity as investors question the ability of active managers to outperform the market. But some investors argue that the distortions inherent in indices merely replace the risk of underperformance.