Bloomberg — It’s hard for even the most-seasoned veterans to make sense of the market right now, with bonds rallying alongside equities one day, and the next day both falling.
“We’re in a universe of equities and bonds going down together. There’s a lot of instability,” said Peter van Dooijeweert, managing director of multi-asset solutions at Man Group, who joined this week’s “What Goes Up” episode to discuss what he sees as the right assets to be in now. The 60/40 portfolio isn’t exactly “dead,” he says, but “my question is, was it ever really alive?”
Below are lightly edited and condensed highlights of the conversation. Click here to listen to the whole podcast, and subscribe on Apple Podcasts or wherever you listen.
Q: It seems like an especially tricky time to be involved in risk parity. How are risk-parity strategies reacting to this environment? Are they abandoning their old playbooks? Are they thinking outside of the box? What are some of the discussions going on around risk parity these days?
A: It depends on how you manage it and it depends on what the risk-parity fund is set up with. So, for our own risk-parity funds, they actually have a weighting in commodities. So you start off the year, if you’re a 60/40 manager and you’re stuck with bonds and equities. They both went down the first quarter and what are you supposed to do about that? And it turns out if you diversify your bonds and equities -- and that’s what risk-parity tries to do -- it tries to diversify first between bonds and equities, so it takes more bond risk. Secondarily, we might look at other asset classes. We do use TIPS for inflation, we have commodities, and I think a lot of our peers, as well.
The huge spike up in commodities has been a big benefit for risk-parity. So I don’t think you see a substantially horrible underperformance versus, say, 60/40. And it also goes about how you risk-manage it. There are very passive versions of this where you just own bonds and equities and you own too many bonds. The more actively you manage it, you start looking at correlations among these things, right? What if it turned out that all of my assets were correlated and they all went down together? Then my risk-parity matrix is a bit wrong, right? I’m trying to target a 10-vol or a consistent volatility in my fund. If everything goes down together and I have no diversification, that’s problematic. Firms like ours, we have correlation overlays to help mitigate this. So between correlation and trend overlays, things that take you out of, basically, assets that aren’t working.
We take some of those approaches that we see in our risk-parity fund and say, why don’t you start applying this to your own portfolio? Even if you don’t do the risk-parity approach, you at least have something going on that. Hey, bonds and equities are correlated, they’re not supposed to be correlated, that’s bad for me, I’ll cut some risk here. If you’re taking that approach, you’re surviving, you’re probably in line. Nobody wants to be in line, but after years of outperformance, that’s not bad. And bonds are at a level where they might be useful again, and that’s probably not in everyone’s mindset. Last year clients would say, are bonds still of any use? Should we get rid of them? What should we do? This year, 200 basis points higher in bonds and, should I just get rid of these? Should I sell these? There’s a bit of a little panicky feeling and I would say they’re dead wrong, but when I see a CPI print of 8.5%, eh. There’s a little something that makes you feel awkwardly uncomfortable about that.
Q: Speaking of the selloff that we’ve seen in bonds and stocks, we’ve heard a lot of people say that 60/40 is dead. What do you make of that? And where you might recommend people find diversification?
A: I’m not going to say dead. My question is, was it ever really alive? In a sense that it was kind of random to begin with. I mean, if you think of a weighting 60% in equities, 40% in bonds, on a risk basis, you’re like 90% equities most of the time, right? Occasionally bonds sell off, usually equities go up. But most of the time for the last 30 years, you’ve just wanted to own a lot of equities, and that’s what 60/40 pretended to let you do.
Where we are now is a bit different. We’re in a universe of equities and bonds going down together. There’s a lot of instability. That instability is disconcerting. If they’re both going down, I need to find things that don’t behave like bonds and equities, which means commodities. And so it’s always great when a person like me tells you, you should buy a bunch of commodities because that’s diversifying. And your investor will say, but crude was like $132 two weeks ago, and it was minus $50 two years ago. So where am I supposed to live with that asset? I don’t have any reasonable way to use it. But the truth of the matter is if you’re going to get out of this “is-60/40-dead?” conundrum, or at least find a place to stay while you figure out what you’re going do with 60/40 and bonds, it’s got to be multi-asset, whether it’s multi-asset via commodities or real assets, infrastructure, hedge funds. You need to find different ways to make money and that’s the challenge that everyone’s faced with right now.
Q: Is there anything popping out in the real-asset space that’s attractive in this environment?
A: We tend to focus on the liquid part of the curve of the asset classes. Perhaps buying an airport works, but that’s not what we do. So we invest in liquid assets, we risk manage them and we find ways to make them fit in portfolios and using the risk control, we try to suck something more out of them.
In today’s universe, I think you do have to live in commodities. It’s just, you have to have some approach to it. There has to be some, how do I get out of this -- is it as simple as a stop loss? Maybe; you can stop in and out of a position. I don’t find that a very satisfying answer. So the way we tend to look at it is on two bases. One, a trend format, and that’s something you should expect from Man Group; we have a big trend-following firm. But it turns out in these big regime shifts where markets go through six, 12-month regime shocks, you have very long moves in asset classes. So we’ve seen it in bonds, they’ve steadily sold off. We’ve seen commodities steadily rally. Admittedly, there’s a bit of a war premium that’s built in there, but that’s a starting point of how you might go about using them.
Now maybe you use trend or maybe you use some other lead/lag models. It turns out when commodities start to go down aggressively before a big market correction, it’s a good signal that equities could be in trouble. So if you look back to Covid, commodities went down first and then equities tanked. So the more you can deal cross-asset, and the more you can take signals from these cross-assets, whether it’s from emerging markets to warn you about commodities, or FX to warn you, the more integrated your portfolio can be. And to some extent it takes an asset manager to do it.
Q: How difficult has it been to discern a message from the market recently?
A: Some people have mockingly said about us in finance that in 2020, there were thousands of experts on virology, and then in 2021, there are tons of experts on inflation. In 2022, there are geopolitical and war experts, so they know exactly how all these things play out.
So if you go back, I remember Hurricane Katrina -- oil was a driver of the market. Stocks went down when oil was going up. It was laughably $40 a barrel, I think, then. And so you kind of knew what you were supposed to look at. Covid, you maybe look at case counts. But mostly for me, I like to look at which assets are moving. And so in the GFC [global financial crisis], we looked at funding spreads, like is there stress in the market? Are banks able to borrow? So we have all these metrics we look at.
This one defies that. There was a little period where oil was going up and then rates would sell off, and then equities would sell off, and it was a ripple each time. And then March just blew your whole theory out of the water. There’s this big run-up in rates at the end of March, along with a big run-up in equities. And you don’t know how to grapple with that if you’re trying to make a narrative.
The narrative that came out of the end of March, which felt a little contrived, was stocks are not so bad in inflation because they have pricing power. And so the people who are spreading that narrative, there’s some rationality behind it. But how many of those were saying last year, with yields this low, you have to own stocks because they have earnings yield, and so that spread to the Treasury is really valuable, and they should trade at a multiple that’s more in line with treasuries. To me, that’s also laughable.
So I think that’s the challenge of this market is getting your head around that there isn’t a single line item of what we can look at. And that’s a change from what we’re used to. Now it’s a little bit head-scratching. So the more you can diversify, the less pain you get, as long as you understand the totality of the diversification.