1) Rebalance when volatility strikes.
In most asset classes, we suggest taking steps to maintain the strategic or long-term target allocation designed to achieve your long-term goals.
As markets rise, positions may need to be trimmed and cash held or reallocated to markets where valuations are better. As markets fall, the opportunity may arise to restore the target allocation.
2) Reduce price volatility with income-generating assets.
Income is a sometimes-overlooked component of portfolio returns. To potentially improve the income-generating ability of a portfolio, you can lengthen the duration (a measure of a bond’s or bond portfolio’s sensitivity to interest rates) of your high-quality bonds (using a neutral overall duration and yield-curve profile). Dividend-paying stocks and real estate investment trusts (REITs) can also offer additional streams of portfolio income.
We view the current difference between the yields of lower-quality and higher-quality bonds as not worth the increase in default and market risk.
3) Use cash to your advantage.
We expect markets to stay volatile. On rallies that take benchmark indices, (e.g., the S&P 500 Index) above our target levels, we suggest realizing some of the gains from U.S. equity holdings and placing the proceeds in cash–to await a better entry point in the coming months.
If a portfolio already holds a sizable amount of cash, there is no need to raise more; instead, investors should be prepared to invest cash should markets correct in the coming months.
4) Consider greater exposure to emerging market equities and sectors that represent higher-quality earnings.
Investing in international assets is an important way to diversify a portfolio. In recent years, U.S. equity markets have led global markets, but that trend may be changing. Currently, we are most favorable on emerging market equities.
Valuations in many emerging markets look attractive, and recent economic data point to stable economies in China and other developing countries.
Within U.S. equity markets, we favor sectors such as Information Technology and Industrials, areas of the market with higher-quality earnings.
5) Add strategies that can benefit from various market conditions.
A bear market can occur with little warning, so adding assets that can profit in both up and down markets may help prepare a portfolio for possible market downturns.
The hedge fund strategies we currently favor are equity hedge and relative value. Private equity and private debt may offer additional potential returns for long-term investors. These asset classes can provide access to innovative, fast-growing companies and to high-yielding debt.
Now may be a good time to begin building an allocation to private debt ahead of an eventual economic downturn that could provide fertile opportunities for distressed debt managers.
Alternative investments are not suitable for all investors and are only open to “accredited investors” or “qualified investors” within the meaning of the U.S. securities laws. They are speculative, highly illiquid, and designed for long-term investment and not as trading vehicles.