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Fed Action - Twisting
Fed Action - Twisting
Fed Action - Twisting
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Lisa Shalett and the Chief Investment Officer Team
SEPTEMBER 22,
2011
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As such, we recommend that investors take a cautious and conservative approach as we expect volatility will continue. We suggest three primar y risk mitigation strategies for investors in this environment to deal with sustained elevated levels of risk:
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Diversify Risk: Our advice is anchored on our strategic asset allocations, and we have encouraged clients to look within asset classes for opportunities to diversify. Within equities, we have focused on ensuring balanced global exposure and reducing excessive home-country bias. Within fixed income, we have emphasized multi-segment and multi-country exposure, including actively managed corporate high grade and high yield as well as local currency denominated Emerging Market sovereign and corporate debt. Diversification strategies also include expanding asset class exposure where correlations to equities have been low; e.g., real assets, alternatives and precious metals (gold). Reduce Risk: We have been clear about our aversion toward market timing and attempts to go to cash. Instead, reducing risk can be about exploiting volatility to upgrade exposure to the scarcity themes of: Growth, Quality and Yield. Today, valuations suggest those themes are available for patient investors at historically attractive entry points (in equities: multinational dividend growing equities; in bonds: highly rated credits and select municipals). Furthermore, the current environment supports consideration of principal and inflation protection oriented strategies. Actively Manage Risk: Periods of high volatility provide opportunities for more frequent portfolio re-balancing as asset allocation drifts. A more aggressive approach to active risk management allows a more tactical approach to asset allocation, and we have suggested the use of global flexible managers for a portion of equity allocations (10-30%) for investors who need to generate absolute returns.
A final note around risk management is perspective. Although we acknowledge the complexity of the environment and the apparent lack of positive catalysts for markets right now; investors are already discounting significant amounts of risk, with equity risk premiums approaching March 2009 levels (+6%), which marked a market bottom and have only been higher once in the last 35 years (November 2008). Patience has historically been a virtue.
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Supporting Details: IMF Global Outlook. This quarterly report, which was released on Wednesday as a preview to the IMF weekend meetings in Washington D.C., revised down materially its forecast for global GDP from 4.5% in both 2011 and 2012 to 4.0% in each year respectively. Of most concern was the outlook for developed economies, where growth is forecast to be a meager 1.6%. As the report noted, the issue is less about the level of absolute growth than with the persistent imbalances between developed and emerging economies. With the debt deleveraging issues weighing on the West reasonably well documented, the more provocative observations were around mounting pressures in Emerging Markets. Unless emerging economies develop self-sustaining mechanisms like constructive monetary and currency policies, inflation containment as well as development of internal consumption demand, global growth could be even weaker. Implications of the Feds action. Yesterday (Sept. 21), the Fed announced what had been widely telegraphed and discounted in markets, that they would execute Operation Twist, whereby they would extend the duration of their portfolio of US Treasuries by swapping out $400 billion in short-term paper for longer dated 8-year plus bonds. The goal of the program is to reduce long-term borrowing rates and flatten the yield curve while keeping the total size of the Feds balance sheet unchanged. In addition, the Fed also announced that they would continue to roll and maintain their ownership in mortgage backed securities as the agency debt that it owns matures. Both actions are aimed at stimulating the weak housing market. While nothing in the Feds actions were surprising, investors were taken off guard by the juxtaposition of these somewhat modest actions with the very strong language around what the Fed termed as significantly increased risks to the outlook stemming from Europe.
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Spencer Boggess,
CIO, Alternative Investments 212-449-3043
Tom Latta,
Global Head, Traditional Manager Due Diligence 201-557-0258
Anil Suri,
CIO, Multi-Asset Class Modeled Solutions 212-449-3385
Chris Wolfe,
CIO, PBIG and Ultra-High Net Worth Customized Solutions 212-236-3159
Jim Russell,
CIO, Portfolio Construction and Multi-Manager Solutions 201-557-0079
Bill ONeill,
CIO, EMEA 44-20-79955745
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