Asset allocation and new rules: a world turned upside down

It’s been a busy few months since President Trump returned to the White House. Markets are now
pondering in not just a political shift, but a structural policy regime change. Tariffs are back. Fiscal
stimulus is accelerating. The old ruled-based multilateral world order is over, and

predictability has increased. Everything seems now possible. For asset allocators, this isn’t just about
managing volatility and return. Conviction is low.

Essential for managing client portfolios, both retail or institutional, HNWIs or smaller affluent clients,
has always been a good understanding of our clients’ tolerance or appetite for risk, their specific
longer and short-term capital needs, their tax situation and our assessment of risk and return
opportunities in financial markets. The latter came always to our frustration as we are always harsh
judgers of our work but never has the range of potential range of risk outcomes been as broad as it
is now. What has changed is abondance of tail-range outcomes. So, what are they and what does it
mean for portfolio construction?

Inflation and interest rates. A once deflationary trend driven by globalisation, technology, etc – has
aged, and so a cyclical inflationary one after Covid emerged. It is now possible to foresee a scenario,
where higher tariffs result in much higher inflation and cost of goods to end consumers or even
product shortages, or an alternative one where worst fears are overstated, supply chains adapt
and/or policy implementation is lenient. How different central banks react to this is also unclear and
similarly what happens to bond yields consequently.

Credit risk and sovereign risk. Corporate risk is generally good due to better standards after the
financial crisis, but it is difficult to forecast a trajectory for US debt. Higher fiscal deficits could be
offset or not by the devaluation in the dollar or tariff/import suppression. Could investors worry
about the solvency of the US treasury when borrowings are funded by international investors? Can
stablecoins suppress traditional sovereigns or are they a seismic systemic risk as large owners of (US
mainly) government debt?

Cross market correlations. Overall equity markets have been highly correlated across geographies,
though a bear market for Japanese stocks and recently for Chinese stocks happened during periods
of good world equity market performance. Is this decorrelation about to increase as the world
becomes less globalised?

As a result, the 40/60 average portfolio is still relevant, but more caution is needed on the bond
component. Historically, bonds outperformed when equities declined. We are less convinced now.
We would complement cash to the bond portfolio weight and avoid duration risk. We would also
have a very geographically diversified and currency hedged portfolio. We would replace high yield
with emerging market issuers.

The flip side is that there could be more opportunities for manager and stock selection in the equity
portfolio. We would look at niche and highly specialised managers that operate in more un-efficient
markets and geographies. Again, offsetting market risk with some market hedging and modest
commodity or gold exposure.

Last and not least, portfolios should be tailored and treated differently depending on client
objectives and overall risk tolerance. If volatility creates opportunities, we want to tactically move
away from a more conservative stance and take on selected risk. While we lack conviction on rates
and major markets, we have high(er) conviction in other less invested areas such as Asia.