Thursday 28 Mar 2024
By
main news image

This article first appeared in Personal Wealth, The Edge Malaysia Weekly on July 22, 2019 - July 28, 2019

A typical investment portfolio today would mainly consist of traditional assets such as equities and bonds. Investors would increase their allocations to bonds during turbulent times and decrease these during periods of growth.

However, this may not be the best approach going forward, considering that the gap between the two asset classes has narrowed, says Paul Sandhu, head of multi-assets quant solutions and client advisory for Asia-Pacific at BNP Paribas Asset Management in Hong Kong.

Due to market-changing events such as financial crises, trade tensions and new investing technologies, equities and bonds are now more closely correlated. To ensure that they are able to achieve the most effective balance between asset classes, investors should look beyond the traditional allocation strategy of equities versus bonds and implement strategies that involve a more diverse set of asset classes, says Sandhu.

“Investors need to take into account a larger set of variables when making investment decisions. The correlation between equities and bonds is going up. So, if a downward spike occurs in the bond market, there will be a similar downward spike in the equity market as well. Thus, investors will be hit twice as hard,” he adds.

Sandhu was speaking on the sidelines of the recent International Institutional Investor Series 2019, organised by the Malaysian Association of Asset Managers. He was part of the panel session on “Active vs passive fund management”.

To mitigate the tail risks of these traditional asset classes, investors can look at hedging their portfolios with derivatives, he says. As volatility is considered low at the moment (as opposed to the recent spikes in volatility), derivatives have become less expensive.

That means investors will be able to buy cheap protection from the downside, Sandhu points out. “It can be as simple as having an equity position and then getting a manager to buy puts and sell calls on the upside for them, effectively creating a volatility corridor that walls off the downside.”

Another strategy that investors can take into consideration is the risk barbell strategy, which will prepare them for any market situation, he says. This can be done by allocating a portion of their portfolios to very conservative assets and a portion to more alpha-generating assets. “For example, they can put a portion of their portfolios in shorter-term investment-grade bonds or high-quality equity investments and then layering these with high-yield bonds.”

While there are many alternative strategies and products to consider when making portfolio allocation decisions, including the use of private equity and private debt, the yields of these asset classes have decreased, says Sandhu. He suggests that investors look at more structured solutions instead, such as fixed maturity products (FMPs).

FMPs, considered an alternative to fixed deposits, are closed-end debt funds with a fixed maturity period. Unlike open-end debt funds, FMPs are not available for subscription on a continuous basis. “You are able to lock in the [currently available] yield of these products that will pay sometime in the future,” says Sandhu.

“We [at BNP Paribas Asset Management] have been distributing a lot of FMPs recently. We are also working on FMP strategies that have some yield enhancement so that they have a bit of leverage included to give investors a little boost. This would fit into the strategy I mentioned earlier — shielding investors from the downside while providing them with some derivative strategies so that the product is less correlated with the rest of the market.”

While the gap between the different asset classes narrows, geopolitical activities around the world are causing markets to be less correlated with one another. That means there is a significant diversification benefit from investing in different geographical markets and currencies, says Sandhu.

Investors should also look at foreign currencies. “The US dollar is a good place to be. Emerging-market currencies are good too, but in hard currencies,” he says.

 

AI in portfolio construction

Amid intensifying challenges such as volatile capital market returns as well as fee and margin compression, investment management firms around the world continue to undergo a business transformation. Some have started to employ artificial intelligence (AI), particularly to improve business and increase efficiency.

BNP Paribas Asset Management is one of those using AI in its business. Sandhu says the firm uses the technology in various parts the business, including an intelligent translation engine that translates documents, such as contracts and fact sheets, to the local standard.

Soon, AI will form a bigger part of an investment manager’s business, he says. This will greatly help the team with diversification, considering that AI does not think the way humans do.

“Let’s say I have US$100. To diversify, I would give 20% of that to five equity managers. If these managers all think the same, have the same portfolio construction process and make the same decisions, I am not actually diversifying,” says Sandhu.

“Such an issue would not occur with AI. It has a different thought process, which provides me with diversification benefits. Having said that, we are not looking at introducing a portfolio constructed solely using AI at the moment. Humans and machines should complement each other.”

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.

      Print
      Text Size
      Share