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The ‘old normal’ is back. Here’s what it means for asset allocation

A ‘normalisation’ of economic conditions means it’s time for investors to reassess how they think about risk, argues Pendal multi-asset PM ALAN POLLEY

AFTER 15 years of the ‘new normal’, the ‘old normal’ appears to be back as central banks return to more conventional monetary policy.

That’s potentially good for investors, argues Alan Polley, portfolio manager with Pendal’s multi-asset team. But it may mean a reassessment of asset allocation.

“Over the past decade and a half we’ve had what was termed the ‘new normal’,” Polley says. “Now we are back to the ‘old normal’. The way things were before the GFC.”

“The last decade and a half, post the global financial crisis, we had global central banks taking non-conventional monetary policy to the extremes.

“They took interest rates close to zero. Some countries went negative,” Polley explains.

“It means we’ve had very low returns from traditional markets like bonds and equities.”

Valuations were pushed artificially high because interest rates were low, and there was relatively little income, he says.

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“Absolute returns were quite low. Inflation was low too — and of course that was part of the reason why central banks were doing this extraordinary monetary policy.

“But nevertheless, absolute returns were unattractive.

“The whole return environment has been challenging over the last decade-and-a-half.”

Changed capital allocation

The ‘new-normal’ environment forced investors to change how they allocated capital.

“Returns were lower, but investors still had the same return objectives – something like CPI plus three or four per cent.

“It meant that the probability of achieving those target returns were much lower,” Polley says.

“It forced investors to chase risk and go out the risk curve. They shifted out of the traditional markets and put money into higher risk assets and hoped the world didn’t turn against them.

“Investors pushed out into small caps, into high yield credit, into emerging markets, into less liquid investments.

“They sold optionality for income. Private markets became very popular. They took on additional risk in some form, whether it be liquidity risk or market related risk or even complexity risk,” he says.  

Style bias

Alan explains low interest rates also introduced style bias – investors started chasing growth.

“Growth stocks with longer duration outperformed value style investing for 15 years. People started using the term TINA – there is no alternative,” Alan says.

“People were changing their asset allocation, drifting away from defensive assets such as bonds and putting more into growth assets such as equities than they probably should have.”

But the world has changed over the past two years. Interest rates are back to long-term, historical averages. The ‘old-normal’, which was the world before the GFC, is back.

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“We think bond rates are now close to normal type levels. Likewise equities valuations have adjusted. Our concern around high absolute valuations for equity markets aren’t as prevalent anymore,” Alan says.

Positive outlook

The good news for investors is the outlook is pretty positive over the next decade.

“There is less need to chase risk with non-traditional assets. There’s less need to shift out the risk spectrum. Chasing of liquidity premiums is less necessary now.

“Investors need to ask themselves: do they need to chase risk when bonds have again yields of around five per cent, and equities have reasonable dividend yields?

“Investors can also start thinking of de-risking their portfolios out of equites, because they had piled into equities out of bonds. Bonds are more attractive,” Alan says.

“Investors can be in quality equities and bonds and have a greater likelihood of achieving their return targets. That’s a great environment for investors versus where we’ve been,” he says.

“So investors should be thinking about leaning back into traditional asset classes out of non-traditional asset classes, de-risking their portfolios and start running a more ‘old normal’ portfolio for this ‘old normal’ environment.”

This is especially important for those in or approaching retirement, having the benefit of de-risking into lower risk and less complex assets but still getting an attractive return and income, Polley argues.

About Alan Polley and Pendal’s Multi-Asset capabilities

Alan is a portfolio manager with Pendal’s multi-asset team.

He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.

Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

Find out more about Pendal’s multi asset funds:

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at November 15, 2023.

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