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Five portfolio construction themes
1. Don’t delay on decision-makingWe hear it in almost every client conversation: There’s always a reason to delay taking action. Whether it’s an institutional investor having difficulty conducting due diligence meetings amid the pandemic or an individual investor waiting for a more attractive entry point, many investors are freezing assets, postponing rebalancing or delaying new allocations. Related, many investors are over-allocated to cash, reluctant to take action due to fears that the market may be overvalued.
We don’t think these are winning strategies. For sure, all investors should hold some cash to meet spending needs, and prudence is always important. But if investors have cash to deploy, they should. If they have a long-term rebalancing plan, they should execute it. And if they believe funding a new allocation will help optimize portfolio construction, they should do it. We offered a range of specific ideas in earlier sections of our outlook, and the following themes help carry them through.
2. Find new ways to generate incomeWe’ve been hitting this point for a long time, but the basic message still holds true: With ultra-low yields across traditional fixed income asset classes, investors need to cast a wider net. And we also think investors will soon need to consider how inflation could be eroding their purchasing power. As such, we suggest exploring different areas of the fixed income landscape, dividend-paying equities and alternatives such as real estate, real assets and private credit.
But in doing so, it is critical to understand the types of risks this entails — and be deliberate in choosing those risks. To help in this process, we broadly categorize asset classes into buckets of interest rate risk, credit risk and equity risk. Each offers different yield and volatility profiles, and we suggest investors diversify across income opportunities and risks, as shown in Figure 6.
3. Focus on the bright light, but get through the tunnelThis is where our near-term/long-term views come into play. At our most recent GIC meeting, we spent time focusing on how immediate-term risks like the surging coronavirus pandemic and a lack of new U.S. fiscal stimulus could harm economic growth and financial markets. But we also talked about the light at the end of this very long tunnel, as we expect economic growth will improve, volatility will lessen and markets will be shaped more by fundamentals and less by macro risks as we progress through 2021.
As such, we think a balanced and modest risk-on portfolio stance makes sense in 2021. As reflected in our asset-class-specific views and the themes we’ve discussed throughout our outlook, we think more defensive areas of the equity market continue to look attractive, but it’s also time to lean more toward some cyclical areas. And we prefer credit investments in the fixed income space, but not to extremes. Likewise, we think investors should take a hard look at private, illiquid investments and a wide variety of alternatives and real assets, both for their return potential and defensive and diversification characteristics.
At the same time, we think investors should continue to focus on environmental, social and governance factors across asset classes. ESG considerations can potentially help portfolios generate additional returns, help manage risk and increase portfolio efficiency.
4. Diversification remains our highest conviction tradeThe days of the traditional 60% equities/40% fixed income portfolio are well in the past. The 60% part may prompt too much volatility for the return offered, and the 40% no longer provides either a portfolio ballast or sufficient yield.
For sure, public equities and fixed income remain a critically important part of almost all asset allocation models. And we believe ample opportunities exist across those markets. But in reality, most investors are under allocated to alternative investments in general and illiquid markets in particular. Public alternatives — including long/short strategies, real estate and infrastructure — can provide valuable diversification. And long-term investments in private equity and private credit, as well as private real estate and real assets such as farmland and agriculture, can play a role in most portfolios.
5. Focus on selectivity and active managementThis final theme may be the most important. Given current valuations, long-term returns across asset classes could be challenged. And without exception, all members of our Global Investment Committee and portfolio management teams are finding investment ideas that are highly idiosyncratic and fast-moving.
Selectivity, research, nimbleness and confidence can all make a difference.
All market and economic data from Bloomberg, FactSet and Morningstar.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Socially Responsible Investments are subject to Social Criteria Risk, namely the risk that because social criteria exclude securities of certain issuers for non-financial reasons, investors may forgo some market opportunities available to those that don’t use these criteria. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
Nuveen provides investment advisory services through its investment specialists.