Atul Lele, the highest-ranking Australian national working for famed US hedge fund Bridgewater Associates, has warned that investors became much too accustomed to a friendly investing environment during the long post-Cold War bull run, calling attention to the need for resilience in portfolio construction and how to build it.
Lele, who leads Bridgewater’s portfolio strategist group, said most investors are only set up for a pro-corporate, pro-liquidity, pro-growth, disinflationary environment – an environment that made equities and growth-centric portfolios thrive over the last 10 years.
However, he told Investment Magazine’s Fiduciary Investors Symposium this week that the favourable backdrop is fading fast. The new paradigm is defined by factors including growing labour, tax and regulation challenges; coordinated monetary and fiscal policy; inflationary pressures; and de-globalisation.
Speaking of the rising geopolitical tension between China and the US as one of the standout risks, Lele said investors need to recognise that “we are in a war already”.
“We were in a trade war that’s escalated to a capital war, which has escalated to a tech war. We hope it may move down towards strategic competition between China and the US – the same idea [we] saw between Japan and the US in the 1980s,” he told the conference in Healesville, Victoria.
He said that many investors had predicated their theses on “4o years of global harmony”, but needed to adapt to a world which now has “clearly a lot of conflict”.
Lele said most Australian investors’ portfolios are very US-centric, and effectively “making a bet” that should a war happen, the US would come out on top. But in reality “it costs investors nothing to be more diversified geographically” to capture the risk premiums in the rest of Asia that will diversify most traditional portfolios.
“A bigger point around geopolitics to us is less about planning around all the ins and outs of what different sides have at stake, and more about what investors actually can do and how to deal with it,” he said.
Another commonly perceived risk in US politics is the possibility of former President Donald Trump being voted back into office next year. Speaking at the Fiduciary Investors Symposium at Stanford University earlier this year, Lele’s colleague and co-chief investment officer at Bridgewater Associates, Greg Jensen, said that outcome could impact the “rate of deglobalisation”, as Trump was a vocal opponent of globalism and the US economy’s seeming reliance on foreign manufacturing.
Lele, however, took a more holistic view. “[Our] strategy is based around the idea that we don’t know what the future is going to hold,” he said.
“The idea of macro volatility isn’t based around necessarily any of these particular outcomes, or all of these particular outcomes occurring. It’s about recognising that we’re in a vastly different environment from where we were over the last four years. And, most importantly, most portfolios aren’t set up for that.”
When it comes to building resilience, Lele said a portfolio should be able to “consistently achieve target returns through a wide range of potential future scenarios”. He proposed a four-step framework for evaluation: identifying environments that impact the portfolio, pinpointing the portfolio’s strengths and vulnerabilities, choosing weaknesses to mitigate, and utilising the “levers” available.
The centre of this framework is a vulnerability measurement method based on “environmental biases” rather than on correlations. The causal (reflective of the drivers of market pricing, not simply pricing itself) and reliable (has stale, fundamental linkages) nature of the former has made it a more appealing indicator, according to Lele, and all asset classes have environmental biases of their own.
“If I think about bonds, you’re getting a big stream of cash flows in the future of more payment maturity. In an environment when you get weaker economic growth, that big stream of cash flows is going to be worth more. In that same economic environment, the dividend stream that you get out of equities is going to be worth less.
“The portfolio biases are just going to be the sum of all of the assets [biases].
“We do believe it’s important for investors to move from concepts and the nebulous idea of having more resilient portfolios, to actually building out a framework and defining what it means.”