Whether it comes to economics, geopolitics, or markets, investors are currently very uncertain about the outlook for the next twelve months. In terms of economics, the jury is out on whether the US Federal Reserve’s interest rate hiking program, which began in March 2022 in an urgent effort to tame runaway inflation, and under which rates have reached a 22-year high, will eventually tip the US into recession, or not. In terms of geopolitics, the ongoing war in Ukraine, the Hamas-Israel war, and simmering tensions between the US and China over trade and Taiwan, add to uncertainty. The prospect of Trump, despite his legal problems, becoming the Republican candidate in the US presidential election scheduled for 5 November 2024 is another unsettling factor, especially given his attitude toward the 2020 election result. And in terms of markets, after generally risk-on markets during 2023, consecutive equity downturns in September and October have rattled investors. What should investors make of all this uncertainty? Here are three tips for investors wishing to navigate the uncertainties ahead.
1. Diversification, diversification, diversification
One of the simplest, yet most profound, principles in investment is diversification. It’s a very simple idea: don’t put all your eggs in one basket.

Unfortunately, some investors underestimate the amount of diversification that is needed. Traditional 60-40 portfolios, for example, have delivered a negative return in 21 of the calendar years since 1928 (taking a 60-40 portfolio to be 60% in the S&P 500 index and 40% in 10-year US Treasuries). Equities plus bonds provides more diversification than equities on their own, but are not enough, we suggest.

Market neutral strategies can add diversification by delivering a stream of returns that is uncorrelated both to equities and to bonds. A market neutral equity strategy may invest in equities, but the return profile can be quite different, so, in our view, it’s a different asset class.
2. Be wary of big macro bets
Most people don’t seriously trust crystal balls or horoscopes. Should we trust macro-economic forecasts? All investment involves some level of risk, but perhaps investors would do well to be a little less overconfident about their ability to predict the future. Psychological studies indicate that most people believe they drive a car better than in fact they do. It may be similar with macro forecasting.

In the real world, events are unpredictable. The subprime lending crisis of 2008, COVID, Russia’s invasion of Ukraine, the high rate of inflation in 2022, the progress made in language generation by Artificial Intelligence, and the Hamas attack on Israel, are just a few events that were very hard to predict. Unlike the well-behaved objects studied by physicists (atoms, molecules, cells, planets, stars, galaxies) the economy is largely a mystery. Economies are complex, open systems, containing self-aware agents who are themselves making predictions (and predictions about predictions …). Feedback loops, external shocks, and chaotic behaviour render the forecasts of economists tentative at best. We would be wise to take macro predictions (including those made around this time of year) with a grain of salt.

There are ways of investing that are macro-agnostic. We employ an investment process based on taking the temperature of the market, and which is responsive to changes in investor risk appetite. Our market neutral strategy is designed to have zero beta – its returns are designed to be unaffected by market moves.
3. Be style-conscious
Our third tip is to be style conscious. No, we are not talking fashion (although if you think that some market movements have something in common with fashions …well, we agree). By style, we mean investment style.

A value investment style means buying stocks that are cheap. A growth investment style means buying stocks in companies growing fast. An investor’s style is very important in determining their overall returns. Markets can be understood in terms of pro-value periods and pro-growth periods. Other well-studied investment styles include quality, momentum, and low volatility. Many investors pick an investment style and stick to it. Is this a virtue? Some see it as almost a moral failing to change their style: a sin called “style drift”.

But shouldn’t you change your style if market conditions change? There is no reward for the value investor if cheap stocks go on getting cheaper. The growth investor can find themselves badly exposed, when stocks have become overbought. Both styles – all styles – have their good points and their bad points. So, doesn’t it make more sense to combine them? And doesn’t combining different styles remind you of a tip we already covered: diversification? We believe in flexing our investment style to suit the market environment. We weight more to certain styles, depending on market conditions. We also prize diversification: buying stocks only when they score well on multiple criteria based on a variety of styles.

All our three tips derive from diversification. Style awareness leads to diversification across styles. Realism about forecasting leads to diversification across different possible future events. The search for diversification leads to new asset classes. So our three tips are really one. Diversification, diversification, diversification.

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