A US-based hedge fund manager has travelled to Australia to discuss the issues relating to institutional investment management in the current environment.
Cliff Asness, the managing and founding principal of US-based AQR Capital Management, has warned of lower returns from US equities and bonds in coming years while also highlighting the need to embrace risk, among other issues.
Asness said expected returns from US bonds and stocks are now low versus history, and there’s no reason to expect that returns will rebound to historically average levels, adding that “waiting for expected returns to return to ‘normal’ may be foolish”.
“If the current environment of low but positive expected returns is permanent, you are going to be short a 3 per cent real return for a very long time,” he said.
Asness argues that the “old-school combo” of US stocks and bonds has “far too much equity versus bond risk”.
“While it’s not uncommon that either stocks or bonds have low expected returns at any given point in time, it is shocking that both are this low at the same time today. This makes the 50/50 portfolio particularly less attractive than normal,” Asness said.
“More important, such a portfolio is way too under diversified.”
Asness said “unfortunately, many investors under-diversify as they focus on capital allocations — rather than risk allocations.”
He said risk budgeting can improve results by highlighting the true degree of concentration in certain types of risk — primarily equity risk. Risk budgeting involves calculating an expected volatility for investments and an estimate of long-term correlation between assets, allowing managers to project the future volatility of a portfolio.
Asness said the need to embrace risk is also key.
“Setting up your plan to take and withstand substantial volatility without changing course is likely the leading determinant of long-term success in investing,” Asness said.
Asness said the key to this is ensuring institutional investment managers have the support of management.
“The first, obvious step is making sure investment professionals at the top really believe that their responsibility is to prudently embrace risk. This includes not just the investment staff, but the board,” he said.
“It is crucial to have top level support, since if the investment team reports to non-investment people who don’t buy into this, the whole project will fail at precisely the wrong time.”
