The Shortsightedness Of Investing In Silos

In this late stage of the economic cycle, the tectonic plates of financial markets are poised to shift, and investors will face increased volatility and uncertainty. Building inflationary pressures, rising recession risks, and historically low U.S. equity returns projected for the next decade are just some of the challenges at hand. These shifting sands serve as a warning sign telling investors to consider whether their investment strategy can ride out imminent market pressures and still deliver the outcomes required to achieve their objectives, both in the short and long term.

Most investors build their portfolios in a siloed fashion, meaning that the aggregate investment portfolio is composed of individual silos of single asset classes, each of which is optimized to outperform its respective benchmark. Here at Russell Investments we believe that in today’s changing markets, it is no longer sufficient to allocate portfolios in this manner and evaluate success simply based on whether an asset class beats its benchmark.

Managing portfolios with a siloed approach, asset class by asset class, prevents investors from fully incorporating material improvements at the aggregate portfolio level, as what’s best for the piece is not always best for the whole. For example, an individual equity manager and an individual fixed-income manager will both select securities that they think can outperform a benchmark. Each manager, however, will only have a myopic view of the total portfolio, and won’t necessarily be making investment decisions in light of what the other manager is doing.

Let’s say the fixed income manager believes that a strategic credit overweight makes sense because this gives more room for issue selection than is possible in Treasuries. This credit bias works in the context of a portfolio with the objective of merely outperforming the fixed income benchmark. What if, at the same time, the equity manager sees significant opportunities in cyclical, high–beta sectors? This could lead to an overweight position in high–beta stocks in that part of the portfolio.

Taken together, the fixed income and equity positions could create a significant bias at the total portfolio level towards a “risk–on” scenario. Even though it may be right for each segment, when all the positions are aggregated, the portfolio wouldn’t end up with the best risk-reward structure.

This is why we believe investors need to look at their portfolios holistically—and consider applying an additional level of oversight on top of these managers. In this uncertain market environment, we think that setting a strategic asset allocation, hiring managers in silos, and letting them do good work simply isn’t enough to deliver the returns most investors seek.

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Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a ...

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