Don’t give in to the new normal

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Vanessa Mabophe | Quantitative Analyst | Prescient Investment Management | mail me


Welcome to the ‘new normal’, they say. You see, something’s always considered the ‘new normal’ until yet another ‘new normal’ comes along. Granted, at times, the ‘new normal’ does actually stick. However, most of the time, it’s just noise and like the doppler effect, it will soon fade away.

For the myopic investment manager, the current low-inflation cycle may seem like the ‘new normal’, leaving the manager’s positioning tilted towards current inflation fundamentals. However, this would be an amateur mistake.

Inflation hedges

As far as inflation is concerned, the biggest priority from a positioning perspective should be to not dwell too much on where inflation currently is but rather on the anticipated future trajectory of the inflation.



Eventually, when a new ‘new normal’ materialises and the effects of the extensive global quantitative easing have caught up, the winners will be those who didn’t give in to noise.

The question is: how do you avoid surrendering yourself to the noise while ensuring that current positioning favours the materialisation of persistent long-term returns?

Unfortunately, there isn’t a straightforward answer. There are, however, various strategies one can employ. One of them is the incorporation of real assets into your asset allocation.

Real assets are tangible assets that have an intrinsic value that’s derived from their physical qualities like property, gold or art.

Furthermore, some real assets generally exhibit defensive characteristics. This means that in times of market turmoil and dire economic fundamentals, they’re not affected as much by volatility as traditional assets, and are therefore able to offer relatively stable returns compared to their counterparts.

On the other hand, most real assets can be seen as inflation hedges. This means that when the prevailing inflation rates increase, the value of real assets increases too, thereby retaining the buying power of the investment.

This characteristic is especially important in times of economic booms that are accompanied by higher inflation rates. In fact, in most cases, the value of real assets increases by more than the inflation rate.

Another interesting characteristic of real assets is the extra risk premium they offer in the form of an illiquidity risk premium.

Diversification

Generally, real assets are illiquid, which means that in comparison to traditional assets, it would be relatively more challenging finding a buyer for the real asset.

For this reason, investors in relatively illiquid real assets require additional compensation in the form of an illiquidity risk premium.

For those who already have real assets in their arsenal – great job! As for the rest: what are you waiting for?



From a diversification perspective, real assets are truly ‘real’. Not only do they offer interesting correlations with other asset classes, thanks to their unique characteristics; they also offer interesting correlations within the sub-categories of real assets.

This means that you can ‘load up’ on various real assets without compromising the overall diversification effect within the portfolio.

In conclusion

As a golden rule, one should never adjust long-term return expectations to cater for short-term volatility. Rather position portfolios accordingly at each point of the cycle to ensure that persistent long-term return expectations aren’t compromised.

Though real assets may not be the golden solution to reaching this golden goal, they offer great diversification benefits, have the ability to protect against adverse inflation movements and generally offer attractive real returns over time. That, to me, seems like a valuable investment case worth considering.


 



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