Opportunities on the Horizon: Investing Through a Slowing Economy

Overview | WEALTH OUTLOOK 2023 | MID-YEAR EDITION | 20 Seeking better outcomes with less investor stress Investing is stressful, especially when there are contradicting trends. Investors seeking returns must put their money to work and tolerate some degree of volatility in the value of their investments. There is no reward without some risk, but diversification and processes designed to rebalance portfolios over time may improve risk-adjusted returns. We believe that our strategic asset allocation methodology may deliver tangible benefits to investment portfolios. By spreading risk over different asset classes, SAA can lead to higher risk-adjusted returns over the long term. In periods of acute market stress, a disciplined asset allocation has historically enabled portfolios to mitigate the incidence of drawdowns and has led to quicker recoveries. We view SAA—a disciplined long-term portfolio strategy that involves diversifying among different asset classes and rebalancing exposures periodically —as essential to optimize the process for efficiently achieving investment goals. Four decades of foundational investment studies 2 show SAA can explain more than 90% of the variability in portfolio returns in the long-term, elevating its value-add to any investment strategy. While the benefits of diversification to enhance long-term risk-adjusted returns are well known, sticking to a disciplined investment strategy and avoiding the temptation to “time the market” can potentially lead to tangible benefits, 2 Gary P. Brinson, L. Randolph Hood, and Gilbert L. Beebower, Determinants of Portfolio Performance, Financial Analysts Journal, July/August 1986. Also see Roger G. Ibbotson, Importance of Asset Allocation, Financial Analyst Journal, March/April 2010. especially in turbulent times. That includes both improved returns and a better ownership experience for investors. In other words, SAA could potentially help mitigate portfolio risk and help reduce investor stress during challenging market conditions. Curbing volatility during stressful market conditions AVS is our proprietary SAA methodology. AVS looks forward over a 10-year horizon and is based on the insight that lower current valuations give way to higher returns over time (whereas higher valuations have generally been followed by lower returns). Our framework uses current asset class valuations to produce SRE. This, in turn, informs how the strategy allocates to each asset class in our SAA. The assumptions are updated on an annual basis. In 2022, we witnessed a sharp valuation de-rating as markets tumbled across the board. Given 2022’s market downturn, the high valuation for the US dollar and the likely growth the global economy may experience after recessionary conditions end in the US, our framework forecasts higher risk-adjusted returns over the long term. To measure performance during stressful market conditions, we compare the S&P 500 Index with our AVS Risk Level 3 portfolio from our proprietary AVS framework in terms of volatility, drawdowns and recoveries. There is a belief that during times of acute market stress, the correlation for risky asset classes goes to one, while volatility rises disproportionately. At Citi Global Wealth Investments, we believe this is not a complete picture. Our asset allocation has historically helped to cool down portfolios in heated circumstances. FIGURE 1 looks at the annualized volatility during the last three US recessions and the associated equity bear markets: the dot- com bubble in 2000, the Global Financial Crisis in 2007-2008 and the COVID-19 recession in 2020. These figures have been computed using daily data corresponding to the associated peak-to-trough periods. As shown, during the prolonged equity bear market of the dot-com bubble (from September 1, 2000 to October 9, 2002), the S&P 500 recorded a volatility of 22.9%while our asset allocation showed a volatility of 9.6%- 9.7%. During the bear market associated with the Global Financial Crisis (GFC), the volatility for the S&P 500 was 37.3%while the volatility for our asset allocation was less than half of that at 17.1%. The COVID induced drawdown was particularly short and acute, a fine example of markets in ‘panic mode’ given its intensity and speed. The S&P 500 volatility showed 79.8% while our asset allocation had 35.3%—again, less than half. These results can have potential benefits when applied to investor portfolios.