The COVID-19 pandemic has upended world economies, bringing with it sweeping changes in the way money is managed. Strategies that worked well to generate wealth in the past are likely to bring disappointing results in the years ahead, making it vital for financial advisers to adjust how they approach portfolio management.
Historically, a passive 60% equities/40% bonds asset allocation has delivered steady returns at low cost. Bonds, which are most negatively correlated with equities, cushion losses during stock market downturns, while the higher allocation to equities meant investors didn’t miss out on maximising gains during bull runs – and these gains have been substantial, with Australian shares returning an impressive 9.1% annually over the 10 years ending June 2021, according to Vanguard data1.
However, the pandemic has accelerated trends that have been developing over the last few decades, bringing investment markets closer to a possible turning point. For instance, the reduction of Australian interest rates to a measly 0.10% - from 0.75% at the start of the pandemic – was a continuation of a 30-year slide alongside falling inflation. These low levels not only leave little scope for further cuts, but cloud the outlook for decent bond returns in the longer term. It’s a change that undermines the roles of cash and bonds as defensive assets.
At the same time, massive government spending to support the economy through the crisis has culminated in an inflation spike. Should inflation continue to rise, the Reserve Bank may be forced to lift rates sooner than planned. This could send stock prices into reverse or at least cut short the incredible rally that has followed the pandemic-induced crash in March 2020. Not to mention that the market is now terribly expensive on many measures. As such, return expectations for the next decade are modest, with Vanguard forecasting Australian equity gains of only 3.8%-5.8% over the next decade2. This could prove insufficient should inflation remain elevated.
The glum outlook for traditional asset prices poses a dilemma for advisers that are persisting with a 60/40 asset allocation; not only are poor investment returns likely to lead to disappointed clients, but regulators are also raising expectations of financial advisers. The Financial Adviser Standards and Ethics Authority’s Code of Ethics, which commenced last year, requires advisers to act in the best interests of each client and take into account the risks associated with their advice. Meanwhile, from 5 October 2021, new Design and Distribution Obligations will add to the regulatory scrutiny, requiring that advisers only distribute products consistent with their client's personal circumstances and financial needs.
Rather than hoping that the historical performance of bonds and equities continues into perpetuity, advisers that want to limit the compliance risk associated with a 60/40 asset allocation strategy are turning to active portfolio management. This provides the investment manager with the flexibility to move in and out of investments to avoid poor returns or capitalise on emerging opportunities. It also makes use of alternative assets, which often act independently of equities and bonds and provide true diversification to control downside risk. As such, active management opens up the possibility of achieving target returns while limiting volatility under any market conditions.
Dynamic Asset’s managed account solution delivers a total portfolio approach that allows advisers to select from five portfolios, each with a specific risk and return objective. Advisers can mix and match these portfolios to tailor each client’s portfolio in order to achieve their short and long-term investment goals.
1 https://vanguard.rw-hosted.com.au/VolatilityIndexChart/ui/retail.html
