Investors sometimes need to change their portfolio holdings, however tough this might be, to maximise long-term portfolio returns. However, as well as being in the market, you also need to be in the right parts of the market.
In Hunting for alpha in Asian equities we discuss the importance of being invested in the market, highlighting how the long-term outlook has improved since the start of the year due to higher interest rates and repriced equities. The macro outlook, however, remains murky in the short- to medium-term.
Holding a well-diversified portfolio is one of best ways to protect against the ever-present macro uncertainties. By well diversified, we mean holding a range of asset classes, sectors, and geographies.
When building a portfolio from scratch, constructing a well-diversified portfolio may be relatively straightforward. For those that already hold portfolios, possibly many of them with different investment providers, this may be more complicated. Investors can hold investments for legacy reasons that may no longer make sense, given their goals and the allocation that provides the best chance of reaching them.
The challenges of rebalancing
Rebalancing a portfolio or making more significant changes to better position it for the long term, may necessitate selling investments that have performed strongly. Conversely, underperforming holdings which may continue to underperform may have to be sold, possibly at a loss.
Rebalancing a portfolio when all parts of the market are selling off and sentiment is dire can be especially tough to do. Investors may ask, why sell anything presently, perhaps at a loss, when a recovery may be around the corner? For those facing selling at a loss, this can be psychologically very challenging.
Despite the difficulties such decisions present, investors must focus on having the right portfolio allocation for the long term. Those attempting to make shorter-term calls, and time markets, can be caught wrong-footed. For example, very few foresaw the ‘hawkish pivot’ from the Fed this year.
There is a lesson in this. Global uncertainty and violent market reactions to changes in monetary policy hinder those expressing strong conviction. Additionally, however gloomy sentiment is, and oversold a market might look, it doesn’t imply that markets are due a rally.
Focus on the long term
While the short-term outlook is complex and uncertain, there are still reasons for the long-term investor to be optimistic. While investors should temper their return expectations, we do not believe the engines of long-term growth, which drive markets, have turned off for good. That said, to capture any market recovery, and continue to grow assets, investors will need to ensure that they have the right asset allocation.
Investors allocating to the wrong asset classes or sectors at the wrong time may suffer the worst of downturns or fail to fully capture the gains from a recovery. Having poor asset allocation and selection, high fees, and a lack of investment process, can all drag on performance and be very costly over the long term.
The role that cash plays needs to be borne in mind too. A high allocation to cash has strongly outperformed equities and other asset classes so far this year. However, history shows that being overweight this asset class has acted as a drag on returns over the long term.
During downturns the natural reaction may be to focus on minimising losses and finding ways to be comfortable with continuing to hold the investment portfolio. All investors should consider what is more important, minimising short-term discomfort, or maximising long-term returns? Remember that markets regularly experience pullbacks, and investors that focus overly on the short-term can do so at the expense of hitting their long-term goals (see chart).