Outlook 2024: Three tips for investors looking to navigate uncertainty
Amadeo Alentorn (Investment Manager, Systematic Equities) suggests that common sense principles such as diversification should be prized over overconfidence in forecasting.
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.
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.
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.
Outlook 2024: A pivotal year?
Periods of transition often raise interesting questions, and this year investors are faced with plenty as they look ahead to what 2024 may bring. Will Western central banks finally start cutting interest rates? Will geopolitical tensions calm or further escalate? And what might a fraught US Presidential election mean for the world?
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