The Agile Investor

Taking advantage of shifting markets

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We believe investors should be agile — that is, ready to make adjustments to their portfolios as opportunities arise.

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Opportunities Exist for Agile Investors

Techniques for being nimble include tactical asset allocation, rebalancing opportunistically, and using active managers to watch and respond to market trends. Explore these topics and more in our digital report.

an agile investor considers her tactical investing options

The Agile Investor

Our video discusses why now may be a good time to be more active in your strategy.

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Conditions Are Favorable for Agile Investors

Three forces - improved confidence, supportive policies, and uncertain geopolitics - are coming together to make it a good time for agile investors to consider becoming more tactical within their portfolios.

The global economic climate is changing. Inflation in the U.S. has been slowly returning to its 2% target rate. Healthy levels of of U.S. employment, coupled with rising wages, have boosted consumer confidence. Current conditions create a “sweet spot” for agile investors — those who are willing to take advantage of timely opportunities and innovative investment approaches.

If market stability gives way to volatility, as we suspect that it will, a new set of sector and asset-class winners and losers likely will emerge. Here are a few themes that lend themselves to a more dynamic investment approach.

  • Uncertain policy changes could create market inefficiencies and opportunities for active investors.
  • Following a disciplined plan with occasional tactical adjustments to take advantage of shifting macroeconomic conditions often works during times of uncertainty.
  • We expect several asset classes to trade within a range of values in the coming years, offering opportunities for tactical asset allocation — short-term adjustments to asset class weights based on shorter-term expected performance.

Take Another Look at Active Management

Investors can use a variety of investment styles — active, passive, or somewhere in between — to take advantage of market opportunities. We believe a blended approach may be suitable for many portfolios.

Active Passive

A manager uses discretion to choose securities that a fund will buy or sell in accordance with a particular investment strategy.

 Definition

Also known as index-based investing, a fund seeks to earn the average return of a benchmark asset class or market segment.

High: Involves substantial research and possibly a fair amount of trading that can raise the cost of investing.

 Relative Costs Low: Involves limited trading, so the costs are usually low.

Has historically outperformed toward the end of the economic cycle. Can take advantage of inefficient sectors, such as small-cap equities and high-yield fixed income, where values may be less accurate or have greater deviation.

 Benefits

Tends to work best earlier in the economic cycle. Offers a low-cost way to invest in more efficient markets, such as large-cap equities, where values are typically accurate and not subject to large swings.
  • Management risk — the asset manager’s investment objective may not be achieved
  • Generally higher management fees and operating costs
  • Certain styles tend to drift in and out of favor, which can affect performance
 Risks
  • Concentration risk — indexes can become concentrated in one or more sectors
  • Cannot take advantage of changing market conditions that might affect performance
  • May not be able to fully replicate an index
Active Passive
Definition

A manager uses discretion to choose securities that a fund will buy or sell in accordance with a particular investment strategy.

Also known as index-based investing, a fund seeks to earn the average return of a benchmark asset class or market segment.
Relative Costs

High: Involves substantial research and possibly a fair amount of trading that can raise the cost of investing.

 Low: Involves limited trading, so the costs are usually low.
Benefits

Has historically outperformed toward the end of the economic cycle. Can take advantage of inefficient sectors, such as small-cap equities and high-yield fixed income, where values may be less accurate or have greater deviation.

Tends to work best earlier in the economic cycle. Offers a low-cost way to invest in more efficient markets, such as large-cap equities, where values are typically accurate and not subject to large swings.
Risks
  • Management risk — the asset manager’s investment objective may not be achieved
  • Generally higher management fees and operating costs
  • Certain styles tend to drift in and out of favor, which can affect performance
  • Concentration risk — indexes can become concentrated in one or more sectors
  • Cannot take advantage of changing market conditions that might affect performance
  • May not be able to fully replicate an index

The Best Environment for Active

The macroeconomic environment appears to be improving for active management. Based on Wells Fargo Investment Institute analysis, active strategies have outperformed passive strategies in the latter stages of the past three U.S. economic cycles. Current trends, including higher interest rates, greater asset price dispersion, and increased volatility, can be signs of a maturing economic cycle.

The success of an active approach often depends on the size and efficiency of the market. Investors could benefit from focusing their active approach on asset classes in which active strategies typically have an edge (see chart).

Active Managers Tend to Perform Better in Smaller and Less-Efficient Markets
Success rate is defined as the percentage of months when active strategies outperform passive strategies.

High-Yield Bond Funds

 56.4%

Commodities Funds

 54.3%

Real Estate Funds

 54.1%

Foreign Large-Cap Stock Funds

 53.2%

Emerging Markets Stock Funds

 52.2%

Small-Cap Stock Funds

 51.8%

Intermediate-Term Bond Funds

 51.0%

U.S. Bond Funds

 44.6%

Large-Cap Stock Funds

 43.5%

Mid-Cap Stock Funds

 42.1%

Source: Wells Fargo Investment Institute, Morningstar Direct. Period of study is from January 31, 1987, to December 31, 2016, using monthly data.

About the chart: Active and passive are defined and grouped by Morningstar. Actively managed means the manager uses discretion to choose securities that the fund owns in accordance with a particular investment strategy; passively managed means the manager does not use discretion to choose securities that the fund owns but seeks to construct a portfolio that replicates or mirrors a benchmark index, such as the S&P 500 Index. The study included the analysis of all share classes of equity open-end mutual funds and exchange-traded funds, excluding money market funds, funds of funds, and obsolete funds. Data was extracted from Morningstar Direct using its search criteria to categorize the funds according to their respective asset class and subcategorize the funds as either active or passive strategies. Morningstar’s calculation of total returns account for management, administrative, and 12b-1 fees and other costs taken out of fund assets. Success rate is defined as the percentage of active strategies outperforming the passive strategy. Information is for illustrative purposes only and does not predict or depict the performance of any investment or the likelihood of achieving any return on an investment. The asset classes shown may not perform in a similar manner in the future.

Past performance is no guarantee of future results.

Growth investors may want to be tactical with equity sectors and with international exposure. Qualified investors may consider alternative investments as a way to hedge equity market risk.

Positioning Your Portfolio For Current Conditions

Current conditions may help determine your strategy within different asset classes.

Globalize Your Portfolio

Agile investors should recognize investment opportunities beyond their home country.

Source: Wells Fargo Investment Institute, April 2017

Adjust to Equity Market Dynamics

Although the equity market typically serves as a leading indicator for the economy, the anticipation sometimes overshoots or undershoots future economic growth. We believe the economy will continue to drive higher equity prices into the coming year and beyond, even though they may fluctuate with passing sentiment swings.

  • We recommend cyclical U.S. sectors, such as industrials and consumer discretionary.
  • We believe there is more room for earnings growth and index price expansion in overseas markets due to the respective stages of their business cycles.
  • We recommend that equity investors remain broadly and globally diversified, exploiting periods of volatility to add high-quality stocks to a diversified portfolio.
  • We expect opportunities to emerge in industries that should benefit from trends such as globalization, growing and aging populations, and alternative energy.

See the map for our views on the current environment in some of the more popular international markets.

Adjust Your Bond Portfolio for Rising Rates

As interest rates rise, bond values tend to fall (see chart, which shows the potential impact of various rate changes on bond returns). Against the backdrop of rising rates, investors may benefit from a more active approach to fixed-income investing.

  • We favor intermediate maturities, given the potential for yield pickup.
  • We recommend moving up in credit quality.
  • We are underweight on developed market debt, as further U.S. dollar appreciation would negatively affect performance.
  • As interest rates continue to rise, active strategies should be poised to better capture market dislocations and potentially mitigate downside risks.
About the chart: This simulation only considers price changes due parallel U.S. Treasury yield curve shifts when calculating total returns. It assumes that U.S. and international yield curves would both be shifting at the same time, and by the same amounts. It makes no assumptions about changes in yield spreads on investment grade and high yield securities.

The Impact of Changing Rates on Bonds

How might interest rate increases or decreases impact total return for bonds?

Click on categories in legend to toggle them on or off

Source: Wells Fargo Investment Institute, CMS Bondedge; 12-month forward-looking simulation March 28, 2017–March 28, 2018.

See Index Definitions

Consider Alternative Strategies and Currency Risk

In the present maturing stage of the economic cycle, alternative investments such as hedge funds can offer solid, risk-adjusted returns and relatively low risk for financially sophisticated, qualified investors. It’s also important to understand how currency fluctuations can influence portfolio performance.

  • We prefer alternative strategies with low net exposures, such as Equity Hedge and Relative Value.
  • Hedge funds may offer solid returns and relatively low risk to a portfolio, and may also help insulate a portfolio when asset prices deteriorate (see chart).
  • We currently see a modestly rising U.S. dollar relative to developed market currencies and a fairly stable dollar relative to emerging market currencies.
  • As the U.S. dollar strengthens, buying international assets becomes less expensive, but current international holdings become less valuable when converted back to dollars.

Hedge Funds May Help Qualified Investors Minimize Losses

However, they still offer potential in rising markets

Hedge Funds represented by the HFRI Fund Weighted Composite Index. Global Equities represented by the MSCI World Index. Index returns do not reflect any fees, expenses or sales charges. Unlike most asset class indices, HFR Index returns reflect fees and expenses.

Upside Capture Ratio measures a manager’s performance in up markets relative to the market (benchmark) itself. It is calculated by taking the security’s upside capture return and dividing it by the benchmark’s upside capture return. Downside Capture Ratio measures manager’s performance in down markets. In essence, it tells you what percentage of the down-market was captured by the manager. For example, if the ratio is 110%, the manager has captured 110% of the down market and therefore underperformed the market on the downside.

Source: MPI Stylus, Wells Fargo Investment Institute. 1/1/1990-12/31/2016. Performance results are based on historical performance of the indices shown.

An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

See Index Definitions

Plan for the Long Term, Adjust for the Short Term

While strategic asset allocation sets risk and return expectations for a portfolio over the long term, it may be helpful to occasionally deviate from target allocations to exploit short-term opportunities.

Start With Strategic Asset Allocation, Then Make Tactical Decisions

  • Strategic asset allocation is the longer-term (10- to 15-year) approach to the mix of investments in your portfolio designed to help you pursue your investment goals.
  • Tactical asset allocation decisions (6- to 18-month) are designed to take advantage of shorter-term opportunities in specific asset classes by temporarily adjusting your strategic asset allocation mix.
  • Investors should regularly rebalance their portfolios to maintain long-term target allocations.
  • The best time to rebalance is typically when equity and bond prices are moving in opposite directions, also referred to as “negative correlation,” which we see going forward.

 

Equities

Fixed Income

Alternative Investments

Real Assets

Cash Alternatives

Wells Fargo Investment Institute. Allocations are hypothetical and for illustrative purposes only. They do not represent the composition of any portfolio. There is no guarantee any investment strategy will be successful or that a portfolio will meet its investment objectives. All investing involves risk, including the possible loss of principal.

Income investors may consider being tactical with bond duration as interest rates rise, and moving a bit further out along the yield curve to seek to pick up additional income.

Innovative Solutions for Agile Investors

Trends over the next few years that investors may want to consider include technology-enhanced investing and social impact investing.

Infographic on Active Management trends, includes the stat that by 2020, digital investing may account for 10% of accounts under management. Other trends related to technology and financial services include innovation among active managers as passive funds lose steam, and new ways of analyzing portfolio performance, including active share
Infographic on social impact investing, saying that 1 in 6 dollars currently under professional management is invested using socially responsible strategies. This also lists the four types of social impact investing: exclusions, solutions, engagement, and impact

Investment Expertise and Advice That Can Help You Succeed Financially

Wells Fargo Investment Institute is home to more than 100 investment professionals focused on investment strategy, asset allocation, portfolio management, manager reviews, and alternative investments. For additional information on Wells Fargo Investment Institute, visit our website.

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