Capitalizing on the ever-expanding investment universe

By Van Harlow on June 06, 2011

The sheer variety of investable securities has grown exponentially over the past 50+ years. One way to see this expansion is to review the development of investment indexes, as index creation often precedes portfolio development in a particular asset class by providing a benchmark against which to evaluate performance.

Traditional asset classes are defined as those included in traditional balanced portfolios, such as stocks, bonds, and cash, and that have been widely owned by individual investors since the post-war emergence of modern portfolio theory. See “The History of Absolute Return Investing.”

Modern asset classes are specialized investments that were created or have become more accessible since the advent of broader market participation by individual investors due to tax-advantaged retirement saving plans. Typically their performance characteristics are different from those of traditional asset classes, and in some cases the markets’ volumes are too small for the asset classes to be widely owned by investors.

However, access to investments through traditional mutual funds has sometimes lagged index inception by many years, such as in the case of commodities. Though the Goldman Sachs Commodity Index has been in existence since 1969, commodity portfolios have only become prevalent in the mutual fund market in the past five years. The reality is that many investors remain unexposed to some important diversifying asset classes, including commodities, a circumstance that led to exacerbated losses when asset class correlations converged during the financial crisis of 2008.

The reason for this disconnect is that mutual funds historically have been developed and managed around narrowly defined asset classes, requiring investors and their advisors to assemble numerous portfolios to create an adequate asset allocation. This process can be challenging, particularly for smaller investors; however, with the financial crisis has come a deeper understanding of the need to not only improve diversification, but also to adjust allocations to respond to opportunities and risks that can quickly develop in the macroeconomic environment.

Absolute return portfolios fill a unique and timely role by providing exposure to a number of asset classes to which many investors have traditionally been unexposed or underexposed, including commodities and inflation-protected securities. Additionally, absolute return portfolios allow investors to flexibly manage their exposure to various asset classes by adjusting positions to capitalize on opportunities and, perhaps more importantly, to reduce volatility. This ability to access and navigate a broader investment universe provides absolute return investors of all sizes with the opportunity to optimize their asset allocation and achieve their investment goals regardless of the market environment.

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