Rock Solid Insights

Asset allocation in a post-pandemic world

26th June 2020
Asset allocation in a post-pandemic world
Eliza Bavin
Financial Standard

Within the allocation to growth and defensive assets, it's crucial to diversify - across asset classes and geographies - to protect your portfolio from seismic volatility shocks.

Tim Sparks, Head of Distribution and Marketing at Bell Direct said typically, when returns for one asset class are low, returns for another may be high, decreasing volatility across the overall portfolio.

"Markets go up over the long-term and it is normal to have periods of negative returns. A portfolio with 70% in growth assets, like stocks, and 30% in defensive assets, i.e. income securities - bonds, will typically have one negative year in every five," Sparks said.

"While the impacts of COVID-19 have been unprecedented, and are yet to fully become known, it's crucial for investors to remain steadfast during these periods and recall previous times of uncertainty in recent history."

"It may sound overly simplistic, but economies and markets do bounce back over time."

Sparks said even in the current climate, many investors with a long investment timeframe and clear goal are unlikely to change their strategic asset allocation in a significant way.

"However, the market dislocation which has arisen from COVID-19 presents a number of interesting opportunities and considerations for investors," he said.

When looking at PE ratios, Sparks said caution is needed when looking at market valuations.  In January this year the Australian share market was trading on a PE of 18.4. It's now trading on a forecast PE of 17.8.

"That seems incredibly high given what is currently taking place. While we have seen the emotional shock of lockdown wash through the community, we are yet to see the full economic shock," Sparks said.

"So, given the current valuations the Australian share market may have further falls ahead."

At a stock and sector level, since the COVID-19 outbreak, investors have been increasing their exposure to more defensive sectors; mainly utilities, healthcare and consumer staples.

"The reason for this is, a lot of these companies have strong, repeatable-free cash flows, solid balance sheets and focussed management," Sparks explained.

"However, in a post-COVID19 world, once we are out of lockdown and business returns to the 'old normal', expect cyclical stocks to come in favour."

While cyclicals have been sold down the most since February 2020, Sparks feels that once restrictions lift, demand for their services should increase.

"In the current bear market, there are plenty of opportunities for investors, with quality companies trading at a significant discount," he said.

"It really does pay to do your research and stay on top of macroeconomic developments."

Gary Wilson, senior consultant and member of JANA's portfolio construction research team and capital markets group, said building diversified portfolios is always the ideal.

"However, maintaining adequate risk diversification via headline asset allocation alone will be more difficult with developed world bond yields at extremely low levels and cash rates anchored close to zero in the near term," Wilson said.

"The latent diversification potential available to Australian investors from holding overseas currency exposure is also now reduced."

Wilson said ensuring sufficient portfolio diversification will rely more than ever on top down asset allocation and bottom up portfolio construction skills working together.

"A post-COVID-19 backdrop will be an uncertain one for investors as it will take time for the after-effects of the deep COVID-19 recession on businesses, households and policy to become visible," he said.

"Ensuring the flexibility to respond to further shifts in market conditions will be a critical element of post COVID-19 investment strategy."

 

Originally published in Financial Standard on 14 May 2020