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SHOCKS TO MACROECONOMIC FACTORS

CONTRIBUTORS

Gene Podkaminer, CFA

Head of Multi-Asset Research Strategies, Franklin Templeton Multi-Asset Class Solutions

Laurence B. Siegel

Director of Research, CFA Institute Research Foundation

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This article explores shocks to global economic growth and how investors can defend against them. The authors examine the impact of such potential shocks on the asset allocation decision, asset-liability management and funding sources. The global economy could be posed at an inflection point, and if a regime change occurs it would catch many portfolios off guard.

Investors have experienced relatively healthy returns for the last decade, with recency bias leading many to creep outward on the risk spectrum. The authors contend that, even in portfolios that appear to be diversified, most of the risk typically comes from equities and equity-like securities, which are greatly exposed to global economic growth risk.

To address these concerns, they encourage investors to incorporate economic fundamentals and much longer time horizons into the portfolio construction calculus. Specifically, they argue that true diversification across independent sources of return is the only practical way of reducing exposure to economic growth. The asset classes providing returns independent of the equity market are nominal bonds and real assets (the latter including inflation-indexed bonds) and, for some investors, cash (usually implemented using skill-based assets with a cash-like beta). Many assets marketed as alternatives actually provide equity exposure in disguise.

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