By David Millar
Recently, I have had the opportunity to travel across the U.S. and participate in various panel sessions with investors. It's a great opportunity to address questions that are on investors' minds. Here are three that I received recently about my team's unconstrained investment approach:
Q. Where do you find portfolio ideas?
A. For my investment strategies, we look at the world from a global macro perspective - my team has no preconception of asset classes or geographies. We simply look for good long-term investment ideas across geographies, across asset classes, across sectors and across currencies. All of which we believe will make a positive contribution to the portfolio.
Each idea starts with an underlying theme in which the team has conviction. For example, we may have a view on the direction of Australian interest rates, or the European financials sector - every single one of the ideas that we have in the portfolio will have a specific, tangible story behind why it's attractive.
It's important to note that we're not trying to have an opinion on everything, but we're looking for 20 to 30 good, long-term ideas and then combine them into a single risk-managed portfolio. The minimum hurdle rate for every idea is that it delivers a positive return over the next two to three years in our central economic scenario. Most importantly, all of the ideas need to work well together so that when we combine them, we can achieve our long-term return target with less than half the volatility of global equities, because of the diversification benefits that the ideas bring to the portfolio. Our approach isn't about concentrating "best ideas," it's about putting together the best combination of good ideas.
Q. What worries you?
A. I like to say that my team exists in a healthy state of paranoia - if you're aiming to deliver positive returns in all market environments, as is our goal, you spend a lot of time thinking about what might go wrong.
We have a central economic thesis that, currently, is cautiously optimistic. We think the world is healing, but there are still a lot of potential issues. We surround that thesis with many scenarios, some of which are pretty grim, and examine how that might affect our portfolio. For example, one of our investment ideas is to be long U.K. equities and short Swiss equities. We believe there's value in the U.K. market, but we recognize it's a more cyclical market than the Swiss market. So in our central thesis, we expect markets to rise, and in that environment the U.K. should outperform. But in our downside scenarios, we think about what would happen if different or multiple markets fell. The answer to that can affect how we may implement that idea in the portfolio.
This is the way we think about constructing portfolios: Find ideas that all work in our central thesis, that all work well together and diversify each other, but then keep thinking about other events that could happen and ask ourselves if there is a better way of implementing these ideas that gives the portfolio a little more defense against the downside scenarios.
Q. How do you view correlation?
A. My strategy is considered an alternative strategy because it's not a traditional long-only stock or bond strategy. There's a lot of talk about whether alternative strategies have low correlation with stocks and bonds, and whether those correlations are changing. I'm quite happy for my strategy to be correlated with stocks and bonds when they're going up. My job is to not be correlated when they're going down.
In the 1990s, stocks and bonds were positively correlated - they both went up together and many investors were happy. During the 2000s, stocks and bonds were negatively correlated - they moved in opposite directions. That can still be useful for investors, though, as investing in both stocks and bonds during those times gives a measure of diversification in a portfolio.
But what if stocks and bonds become correlated again - but they are both experiencing losses? That's when alternative strategies can come into play. My strategy is aiming to perform positively over a rolling three-year time frame, independent of the direction of stock and bond markets. So, I'm not concerned with correlations per se, as those change over time, but I'm seeking to provide diversification benefits in all market environments and even when other traditional asset classes are suffering.
For more information on David Millar's investment strategy, visit invesco.com/InvestinginIdeas. Financial professionals can also view our new e-book on the strategy, The Art and Science of Multi-Asset Investing.
Correlation is the degree to which the movements of two variables are related.
Diversification does not guarantee a profit or eliminate the risk of loss.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.
The risks of investing in securities of foreign issuers can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Short sales may cause an investor to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, exposure to potential loss is unlimited.
Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer's credit rating.
Changes in the value of two investments or asset classes may not track or offset each other in the manner anticipated by the portfolio managers, which may inhibit their risk allocation process from achieving its investment objective.
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Disclaimer: The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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