Diversifying with the future in mind 

Since the global financial crisis, the 60/40 portfolio outperformed more traditional portfolio structures. But with a host of factors currently front of mind for investors, from geopolitical unrest, inflation, and monetary policy shaping the investment landscape, there is now a deeper need to revisit how portfolios are structured and the role diversification must play to achieve long-term goals.

We are in a period of transition, and there is a pressing need to take into account the widening range of potential investment outcomes. So, it was a privilege to share Mercer’s US Global Investment Forum Stage with three experts to discuss how to manage portfolios amid a changing backdrop.

Joining me was Christopher Berglund, president of trustees for the Diocese of Western Massachusetts, Nicholas Millikan, managing director and head of investment strategy at CAIS Group and Matt Stroud, senior director, global pensions at Marsh McLennan.

When June’s CPI figures came out at 8.6%, we panellists shared a sense of shock, raising questions on the Fed’s ability to control inflation, and what action investors need to take.

Millikan’s primary concern at the time was the impact of a policy mistake, as it may have the opportunity to tip the economy into a recession, while the risk of stagflation is also occupying thoughts.

This has laid the bedrock for investors to consider how to diversify with risks and opportunities in mind. As such, investors need to add means of diversification to their toolkit.

We firmly believe in private assets – debt, real estate or more diversified assets around hedge funds – for their diversification benefits, and for their potential ability to enhance potential returns and provide inflation protection.

Elsewhere on the macro scene, the IMF has projected strong growth in emerging markets over the next five years, expanding the pool of attractive geographies available to investors. Stroud described this combination of high expected GDP growth and low valuations as being “seductive” for investors, with diversification opportunities becoming available outside of prominent emerging market economies, such as South Korea and Taiwan.

Yet this is raising questions about how investors and managers best instil appropriate levels of governance, particularly when investors are increasingly seeking ESG mandates.

Understanding how your governance committee is going to facilitate your engagement with investment and ESG goals, and help you monitor your progress to evolve, is key, the panel said, while careful manager selection is becoming more important as we see the perks of active management become more attractive.

In short, diversification means a lot more than spreading holdings across asset classes – it means being best placed to seize the broadest possible selection of opportunities, and that means having dynamic expertise.

Berglund told GIF attendees that while his pension scheme may not be the most agile fund, it benefits from Mercer’s political and economic information, helping trustees “fine-tune” asset allocations and weightings. Recently, the scheme looked into investing in private equity and also some foreign exchange opportunities to try to offset some of the currency risks apparent in international equities portfolio.

Stroud too explained how he is responding to diversification challenges, with private equity becoming a meaningful tool in portfolio construction. He said the case for having a meaningful private equity weighting is “probably stronger” looking forward, with opportunities in private real estate also being attractive.

I then asked the panellists which areas or diversification themes they are paying close attention to, with infrastructure, disruptive technologies and utility provision being at the fore of our experts’ minds.

But looking ahead also means being in a position to transition. With net-zero objectives set to shape the future of finance, aligning diversification efforts with future transition pathways is becoming increasingly important.

With the help of Mercer, Berglund undertook an investment beliefs survey among trustees, looking at how ESG and DEI factors can be included within a diversified portfolio.

“In addition to that, we also looked at some of the countries that the companies we were invested in – where they're located, where they're doing business, and their human rights suppressions – to exclude those countries.”

“We just went through our first-year update, and both from an ESG and a country perspective, we are improving,” Berglund told GIF attendees.

Other panellists echoed this sentiment, noting how vital ESG expertise is to creating future-proofed, resilient, and diverse portfolios.

The number of tools in the diversification toolkit is growing, and while the real world is becoming more complex, we believe having the know-how and resources behind you is a crucial step on the path to success.