Despite much uncertainty in the minds of many investors with respect to the path of interest rate hikes in the U.S., the ultimate impact of Brexit on England, Europe and the rest of the global economy, and the outcome of the upcoming presidential election in the U.S., one thing remains certain thus far in 2016–market leadership continues to change and evolve.
I have observed some of these changes in areas such as market capitalizations, styles (i.e. growth to value), sectors, fixed-income and geographies. Investors should be mindful of these areas of changing market leadership as they review their asset allocation strategies for the second half of 2016 and beyond. This review can also help ensure that these investors have the diversification in place to withstand potential future periods of heightened volatility as well as the breadth of asset classes and sectors to assist in delivering risk adjusted growth opportunities.
With this in mind, I offer the following portfolio management ideas for consideration for the balance of 2016:
U.S. likely be considered a safe haven if/when global volatility returns
While I still contend that international stocks are an attractive asset class for the intermediate-longer term, I believe that the U.S. economy is relatively stable and that the secular bull market in the U.S., while starting to lose steam after reaching record highs, should continue for at least one more year.
Overseas uncertainty and fears of an “over-crowded trade” in U.S. Treasurys could result in investors turning to low volatility, perhaps dividend-paying, U.S. equities when market volatility returns–and it will. However, investors would be wise to consider sectors that have historically performed well when the Fed gradually tightened, and to diversify by not focusing just on the U.S. large cap asset class alone (i.e. consider allocations to mid-cap and small cap as well) and to not assume that growth will always outpace value, especially during extended periods of heightened volatility and low comparable yields.
Be wary of Europe but don’t abandon international equities
While we are headed into uncharted international waters with respect to the likely departure of Great Britain from the European Union and a certain amount of caution is appropriate, this does not mean that investors should necessarily abandon international developed market equities altogether as the pullbacks that have taken place in these markets have created several attractive entry points and many central banks across the globe are priming their stimulus pumps to help ensure that their own economic recoveries continue on their grinding ascent forward despite Brexit.
Certain international emerging markets, with China as their most infamous member, have gotten off to a great start so far in 2016, and while they may face more headwinds and experience more volatility than the vast majority of developed market investments, they may now be worthy of additional consideration for those looking to diversify globally.
Consider alternative allocations to commodities
An alternative asset class such as commodities is worthy of consideration to help add a degree of diversification and growth potential given current capital markets conditions. As opposed to trying to pick a particular commodity (crude oil, for example) or select a given class of commodities (i.e. precious metals), investors may want to consider a diversified basket of different commodities to access the commodities asset class. These may incorporate commodity classes such as energy (i.e. crude oil, gasoline, heating oil, natural gas), precious metals (i.e. gold, silver, platinum, palladium), industrial metals (i.e. aluminum, copper, zinc, tin) and agriculture (i.e. wheat, cotton, coffee, sugar, soybeans).
REITs continue to fly under the radar
Despite their strong relative performance thus far in 2016, real estate investment trusts (REITs) have basically continued to fly under the radar of the attention of the media and many investors for some reason. Perhaps this aversion is due to either the lingering effects of the non-traded REIT fallout on advisors or concerns that REITs may not perform well in a rising interest rate environment. Many assume that REITs are synonymous with the housing market and while there may be some correlation with mortgage REITs and housing, there are many other different sectors of REITs available for consideration that are not necessarily as correlated to residential housing such as retail REITs, office REITs and health care REITs.
After the market closes on August 31, 2016, S&P Dow Jones Indices and MSCI is scheduled to even reclassify exchange listed real estate companies, including listed equity REITs, from the financials sector to a new real estate specific GICS sector. The REITs Industry is being renamed to Equity Real Estate Investment Trusts, and excludes mortgage REITs. Mortgage REITs will remain in the financials sector under a newly created industry and subindustry called mortgage REITs. These changes will certainly help portfolio managers navigate the complex REIT marketplace more efficiently and perhaps attract more investor attention to this asset class.
It is also interesting to note that from a historical perspective, REITs have demonstrated that they have actually performed well in environments when the Fed has gradually raised interest rates (the same scenario I believe will take place this time around). For example, during the timeframe of 2004-2006, the Fed raised the Federal Funds Target Rate on 17 different occasions in 25 basis point (0.25%) increments, and U.S. publicly traded REITs, as measured by the Wilshire REIT Index, experienced an average annual total return of 27.7%. It is important to recognize that REITs contain their own set of unique risk factors that should be thoroughly reviewed and analyzed before considering an investment in them directly or through a packaged product structure.
Remember that bonds can be effective for income and growth-oriented portfolios
It has long been my contention that, for income-oriented investors, bonds can provide for a dependable and consistent stream of income, and principal protection when held to maturity. Bonds, whether they are municipal, government or corporate bonds, can also provide for compounded growth opportunities when the income received from the bonds is reinvested.
Additionally, for growth-oriented investors, fixed-income securities can provide investors with downside protection and diversification within a growth portfolio, especially in a highly volatile market where additional, measured, short-term flights to quality are likely.
In my view, investors should be careful not to miss out on the income and diversification opportunities offered by bonds by trying to time future, potential changes in interest rates. History has shown us that trying to time the market, or time interest rate increases or decreases, can be very difficult. With this said, it is important to understand that when interest rates do increase, bond prices may fall and yields may rise.
However, rising interest rates should not impact the interest that bond holders receive on their bond holdings nor should they necessarily change the ability of these investors to receive par value on their bond holdings at maturity. Bond fund investors, on the other hand, may see the interest they receive on their fund holdings change in a rising rate environment and will not receive par value at maturity as there generally is no set maturity on bond funds.
While allocations to bonds may vary based upon market conditions and investor objectives and risk appetites, certain types of bonds, from certain types of issuers, can still find a home in most investment portfolios throughout most market cycles.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.
Forbes.com | August 2016