Thinking Long Term in Different Market Conditions

The effectiveness of rebalancing and tactical tilts in changing market conditions

When investors continually respond to short-term market trends, their moves can work against them. That said, in certain circumstances, shifting market conditions may warrant portfolio adjustments.

• Rebalancing. An investor’s target asset allocation — the percentage of the assets they hold in various types of investments — helps align their portfolio with their goals, time horizon and tolerance for investment risk. Over time, their individual investments’ returns will differ from each other, causing their asset mix to change. This phenomenon is called portfolio drift. To keep their portfolio aligned with their plan, the investor may need to periodically bring allocations back to their targets — for example, by selling down investments that have generated the strongest performance and reinvesting the proceeds in assets that have underperformed. Alternatively, if an investor wants to avoid selling assets, they can rebalance more gradually by dedicating new contributions to underweight assets.
• Tactical tilts. Investors looking to take a more active approach will rely on you as the financial professional. Based on their view of the markets, they may decide to hold slightly more or less of their portfolio in a particular investment type than their long-term targets dictate, based on their view of the markets. Performing these “tactical tilts” with your oversight — and in the context of a sound strategic asset allocation plan — can help them ensure that short-term adjustments don’t throw their long-term plan off track

The Importance of Diversification

The performance of most major asset classes has shifted, at times dramatically, from one year to the next. For many investors, staying diversified helps to alleviate concerns about being in the right place at the right time. It may also help ease anxiety during periods of market volatility.

As an example, current market conditions support the potential value of diversification. Over the past few years, a handful of the market’s top performing stocks, including the Magnificent Seven, have surged in earnings and valuation, and have dominated returns. This has left equity investors with an incredibly bifurcated market. While the valuation gap between the top performing and average stocks is still slowly growing, we believe the fundamentals behind the top stocks do not support such a large differential, and the market concentration in those stocks could be poised for a reversal.

We believe this could be a tailwind for active equity managers who underweight the largest five stocks for diversification reasons. Investors interested in expanding the breadth of their portfolios can turn to market segments including cyclical companies, banks, and defensives. This can potentially strengthen their portfolios against risk and position them to take advantage of market shifts.

A look at bonds

When equities are performing well, recency bias can kick in, causing investors to overweight their portfolios with equities. During such times, investors can consider seeking historical perspective as they reaffirm their long-term goals. In our view, adding bonds to portfolios can mitigate some of the risk involved in equity markets while providing opportunities for income creation.

Bonds differ in duration and rating, and investors may wish to consider adding several types to their portfolios. For example, rotating into short-term bonds can help investors reduce reinvestment risk without taking on the full price volatility inherent in longer-duration fixed income exposures.

Dynamic markets demand agile thinking

Amundi US offers a range of fund solutions for today’s dynamic markets. Learn more at   amundi.com/usinvestors/Investment-Ideas/Dynamic-Markets-Agile-Thinking

^†Diversification does not assure a profit or protect against loss. ^‡Duration: A measure of the sensitivity of the price of a fixed income investment to a change in interest rates. *Correlation - The degree to which assets or asset class prices have moved in relation to one another. Correlation ranges from -1 (always moving in opposite directions) through 0 (absolutely independent) to 1 (always moving together). 

Definitions:

Cyclicals: Stocks whose performance moves in sync with trends in the economy, often because they make or sell items and services that are in demand when the economy is doing well. Defensives: Stocks that generally provides consistent dividends and stable earnings regardless of the state of the overall stock market. Duration: A measure of the sensitivity of the price of a fixed income investment to a change in interest rates. Inflation: A general increase in prices and fall in the purchasing value of money. Emerging markets: Economies of developing nations that are becoming more engaged with global markets as they grow.

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