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Investors have experienced their share of market volatility during the past thirty years, but that volatility compares very favourably with earlier time periods. Developed economies have experienced stable growth, low inflation, and a persistent decline in interest rates. This supported strong bond and equity returns as well as strong diversification benefits. Arguably, investors have had it relatively easy - for the most part!
More recently, we are seeing much higher and more volatile levels of inflation and growth. Quickly rising inflation can harm fixed income returns and dampen their diversification benefits. With a rockier landscape expected ahead, and lower return expectations for equities and fixed income, the "easy" days may be behind us and now is the time to broaden the variety of investments in a balanced portfolio.
Part 4 of the series
The Asset Allocation Team is creating a 5-part series of papers that addresses the evolution in our approach to asset allocation. Namely, how the 60/40 portfolio served investors well in the past, why evolution is needed now more than ever and the approach to asset allocation at TD Asset Management Inc. (TDAM) today.
Our first paper illustrated that fixed income has been a core part of a balanced solution and that the negative correlation with equities has historically given investors a "free lunch", by providing both lower risk with similar returns. However, record low bond yields have not only reduced the return potential of fixed income but also driven investors to search for higher yield, which further weakens the protection it provides. The second paper of the series highlighted how global central bank monetary policies have had a significant and long-lasting impact that will affect all asset classes, but particularly fixed income and its role as a "goalie" for your portfolio. Part 3 of the series discussed why equities should remain a core allocation in an investor's portfolio, the various risks to be mindful of and the particular types of equities investors should be considering.
This, our fourth installment titled Investing in Alternatives is the new norm, outlines how alternative assets can be included in portfolio construction, to improve risk adjusted returns in the current investment landscape.
The new norm
Our new paper outlines why portfolios should include alternative investments as we believe it will help to prepare for a changing investment regime and weakening fixed income contributions. Combining these assets into a traditional portfolio improves return and lowers volatility – lifting risk adjusted returns. Alternative investment are quite varied and include several public market and private market investments that should be considered. These include:
Public market alternatives:
- Foreign exchange strategies
- Options strategies
Private market alternatives:
- Real Estate
Alternative investments expand the efficient frontier, meaning that for similar level of risk as traditional portfolios, investors may realize higher returns. The combination of diversification, downside protection, inflation protection and steady yields can make alternatives a strong addition to traditional balanced portfolios.
Historically for institutional investors only
Many major institutional investors such as pension plans have steadily increased their allocation to alternative assets as they have realized the benefits of diversifying away from fixed income and equity investments. Now, with the ability of individual investors to allocate to alternatives through pooled funds, you can also experience the benefits of this institutional approach.
Be sure to look for our final article from the 5-part series that combines the ideas discussed on how to build better portfolios for balanced investors.
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