Mihir P. Worah, Geraldine Sundstrom
One can hardly imagine a better inflection point to revisit asset allocation frameworks than after the U.S. presidential election, especially given increasing skepticism of free trade and open borders as well as possible changes in economic paradigms that have prevailed over the last several years.
Investors clearly have had mixed feelings about recent developments. Early euphoria on what a Republican sweep in the U.S. would mean for equities has morphed into a wait-and-see attitude as equities consolidate and bonds reverse most of their initial sell-off.
In this outlook, we dissect in detail the current situation, which includes critical transitions that will have substantial consequences for the macro environment that we all must navigate. We also highlight return opportunities and related investment strategies, and, as always, share our views across the major asset classes.
We stress that the current state of valuations and the business cycle, when combined with higher macroeconomic uncertainty, will lead to increasingly diverse outcomes across and within asset classes. Detailed economic analysis and bottom-up security and sector selection must be combined with careful risk management and downside protection. Patience and nimbleness will be required in 2017 – but in light of the current environment, we also suggest reassessing one’s approach to asset allocation.
A "risk-free" asset refers to an asset which in theory has
a certain future return. U.S. Treasuries are typically perceived to be the
"risk-free" asset because they are backed by the U.S. government. All investments contain risk and may lose value.
Capital market assumptions
are for illustrative purposes only and are not a prediction or a projection
of return. Return assumption is an estimate of what investments may earn on
average over the long term. Actual returns may be higher or lower than
those shown and may vary substantially over shorter time periods. It is not
possible to invest directly in an unmanaged index.
Investing in the bond market is subject to risks,
including market, interest rate, issuer, credit, inflation risk, and
liquidity risk. The value of most bonds and bond strategies are impacted by
changes in interest rates. Bonds and bond strategies with longer durations
tend to be more sensitive and volatile than those with shorter durations;
bond prices generally fall as interest rates rise, and the current low
interest rate environment increases this risk. Current reductions in bond
counterparty capacity may contribute to decreased market liquidity and
increased price volatility. Bond investments may be worth more or less than
the original cost when redeemed. Sovereign securities are
generally backed by the issuing government. Obligations of U.S. government
agencies and authorities are supported by varying degrees, but are
generally not backed by the full faith of the U.S. government. Portfolios
that invest in such securities are not guaranteed and will fluctuate in
value. Equities may decline in value due to both real and
perceived general market, economic and industry conditions. Tail risk hedging may involve entering into financial
derivatives that are expected to increase in value during the occurrence of
tail events. Investing in a tail event instrument could lose all or a
portion of its value even in a period of severe market stress. A tail event
is unpredictable; therefore, investments in instruments tied to the
occurrence of a tail event are speculative. Derivatives
may involve certain costs and risks such as liquidity, interest rate,
market, credit, management and the risk that a position could not be closed
when most advantageous. Investing in derivatives could lose more than the
amount invested. Mortgage- and asset-backed securities may
be sensitive to changes in interest rates, subject to early repayment risk,
and while generally supported by a government, government-agency or private
guarantor, there is no assurance that the guarantor will meet its
obligations. Bank loans are often less liquid than other
types of debt instruments and general market and financial conditions may
affect the prepayment of bank loans, as such the prepayments cannot be
predicted with accuracy. There is no assurance that the liquidation of any
collateral from a secured bank loan would satisfy the borrower’s
obligation, or that such collateral could be liquidated. Investing in foreign-denominated and/or -domiciled securities may
involve heightened risk due to currency fluctuations, and economic and
political risks, which may be enhanced in emerging markets
. Inflation-linked bonds (ILBs) issued by a government are
fixed income securities whose principal value is periodically adjusted
according to the rate of inflation; ILBs decline in value when real
interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs
issued by the U.S. government. High yield, lower-rated securities involve greater risk
than higher-rated securities; portfolios that invest in them may be subject
to greater levels of credit and liquidity risk than portfolios that do not. Commodities contain heightened risk, including market,
political, regulatory and natural conditions, and may not be suitable for
all investors. REITs are subject to risk, such as poor
performance by the manager, adverse changes to tax laws or failure to
qualify for tax-free pass-through of income.
is the risk that the investment techniques and risk analyses applied by
PIMCO will not produce the desired results, and that certain policies or
developments may affect the investment techniques available to PIMCO in
connection with managing the strategy. There is no guarantee that these
investment strategies will work under all market conditions or are suitable
for all investors and each investor should evaluate their ability to invest
long-term, especially during periods of downturn in the market. Investors
should consult their investment professional prior to making an investment
is a measure of performance on a risk-adjusted basis calculated by
comparing the volatility (price risk) of a portfolio vs. its risk-adjusted
performance to a benchmark index; the excess return relative to the
benchmark is alpha. Smart beta refers to a benchmark
designed to deliver a better risk and return trade-off than conventional
market cap weighted indices. Correlation is a statistical
measure of how two securities move in relation to each other.
This material contains the opinions of the manager and such opinions are
subject to change without notice. This material has been distributed for
informational purposes only. Forecasts, estimates and certain information
contained herein are based upon proprietary research and should not be
considered as investment advice or a recommendation of any particular
security, strategy or investment product. Information contained herein has
been obtained from sources believed to be reliable, but not guaranteed. No
part of this material may be reproduced in any form, or referred to in any
other publication, without express written permission. PIMCO is a trademark
of Allianz Asset Management of America L.P. in the United States and
throughout the world. ©2017, PIMCO.
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