Trevor Williams
The 60/40 portfolio has been a staple of investing for decades. David Picton, President and CEO of Picton Mahoney Asset Management, explains why investors should consider looking beyond the traditional asset mix in today’s trading environment.
text
Greg Bonnell – With central banks aggressively raising interest rates in an attempt to tame inflation, some investors are beginning to question whether the 60/40 portfolio is still a valid strategy. Well, today our featured guest says that investors may want to look beyond the traditional asset mix in today’s environment. Joining us now to discuss is David Picton, President and CEO of Picton Mahoney Asset Management. David, it’s great to have you on the show for the first time.
David Pickton – It’s a pleasure to be here.
Greg Bonnell – Since it is your first time, we will introduce you to the audience. Tell us a little about yours Company and what is your philosophy.
David Pickton – We are coming up on our 20th anniversary. We have about $11 billion or so of money, with a large focus on alternative investments. We try to provide differentiated return streams to our end investors.
Greg Bonnell – Good. So, alternative investments, let’s try to get into that. Because obviously, as I was saying in the introduction, people have taken a long look at the 60/40 portfolio and whether they made it 70/30 or whatever, but they saw that as a framework. This has certainly been tested post-pandemic with interest rates rising. What do we need to think about?
David Pickton – We like to look at these different asset classes as simply return flows. Stocks rise over time by about 7% or 8%. Bonds are up about 5% or 6%. And sometimes their returns behave differently from each other. And so when you combine those two assets together, especially over the last 40 years, you have a great experience investing in the markets.
Interest rates fell. Every time there was a hiccup in the stock market, the bond market rose. And you had a very good return overall from the whole strategy until we got to a new inflationary regime. And as we saw in 2022, that’s the first time in years that both of these asset classes were not only underperforming, but significantly underperforming at the same time. This was the first time many investors felt a bit of a shock when they opened their statements because neither asset helped offset the other.
Well, what we’re trying to do is take the idea of assets offsetting each other and bring it into the alternative space. So, if stocks and bonds are somewhat correlated, and if we can have another asset class that’s completely unrelated to what’s going on in the stocks and the bond market, we think that if you add that up, and it has a positive return flow over time, now get the diversification benefit, You will get a better risk-adjusted return for the end investor.
Greg Bonnell – Does this take us to what we call market neutral as an important category here?
David Pickton – Market neutral or alpha generating strategies are a very important part of this. So, for example, when you buy the stock market, you are essentially buying the beta. If the stock market goes up, your mutual fund generally goes up by the same amount, plus or minus a little. If the bond market goes up, your bond market mutual fund goes up, plus or minus what the bond market does.
So what we want is to build something that doesn’t focus on either of those betas, and instead focuses on the company-specific drivers of generating a return regardless of what happens in the stock or bond market. The neutral market fits perfectly into this category.
Greg Bonnell – Let’s dig a little deeper into that. What does that mean then? How do you build this type of portfolio?
David Pickton – You are looking to isolate the performance of companies. To do this, you have to find companies that you like. At our company, we focus on positive change, good value, and fundamentally positive change and quality. It then tries to offset that company’s market exposure by adding shorts to the list.
So we like companies with positive change, good value and high quality. We really hate companies with negative churn, poor value and poor quality. So, if we can build a basket of negative change companies that we short, for example, sell without owning, we can then hedge all the market risks of the things we like. We essentially end up with equity-specific alpha left within the portfolio.
Greg Bonnell – Now, does a strategy like this begin to work in concert with a 60/40 ratio, with the traditional mix of stocks and bonds? Has this old strategy been completely phased out or are you doing a combination of things?
David Pickton – Yes, we never turn them away. Because if you look at the very long term, you’ll want to have a stock or beta in your portfolio. You want to have a return that is sensitive to the interest rate in your portfolio. In the very long term, all studies will show that these elements are important building blocks for your mix.
But having only two options in your wallet is a bit like going golfing and having a driver and irons. Well, what about my wedge and putter? How do I put it all into the mix? So we want to add new tools. So the key to all of this is that you have to have a positive return current. It should behave differently than your stock and bond portfolio. This is when you start to get a smoother ride along the way and better risk-adjusted returns.
Greg Bonnell – Good. Let’s talk about risk management as well. It seems like part of the overall strategy is to think about that kind of risk, particularly in this inflationary regime, where we’ve seen both asset classes in 2022 get hit hard.
David Pickton – A big focus for any alternative manager is risk control. We spend almost as much time on risk control as we do on the stock selection portion of the portfolio. We do this in many different ways. We have portfolios that are supposed to be market-correlated, half market-correlated, or zero market-correlated, in a market neutral state. So you always have to have your own risk processes, and make sure that when you say you’re not going to be market-correlated, you’re not market-correlated. And we’ve done a very good job of that over the long term.
And then, secondly, it may increase certain market exposures. For example, in an environment like today where things may be a bit volatile and valuations and options are lower, you can add additional options protection to the mix. And then, finally, within a neutral market, you generally don’t take huge bets on the sector.
Sure, we might like copper or gold. But you don’t build a portfolio of copper and gold and then hedge it all with your technology and banking portfolio. You want to make sure that you’re somewhat restricted in the amount of risk you take within sectors as well.
Greg Bonnell – What do you think of the current market environment at the moment? It’s kind of interesting times. Bond yields rose during the fall, then fell. We entered this year thinking that this was the year of Fed rate cuts. Finally, we’re starting to readjust to all the disruption the pandemic has brought, and it hasn’t happened that way yet.
David Pickton – Well, we’re happy to say that JPMorgan’s Jamie Dimon stole one of our slogans, which means we’re cautiously pessimistic. In other words, we have seen a good move higher in risk assets, especially in the stock market. Technology has certainly driven this. But there has been a lot of good movement across all sectors over the last six or eight months.
At the same time, we had support for interest rates. At the same time, we pushed interest rate cut expectations even further. So the market is taking into account a lot of good news. It takes a lot of growth into account. It takes into account upcoming interest rate cuts. It takes into account inflation relief. And they’re paying double the amount for it, much higher than we’ve seen in the past. So, while we can see how it could work, there are some possibilities where it won’t, hence our cautiously pessimistic tone as we approach it today.
Original post
