In this month’s Kiplinger’s magazine, PIMCO CEO Mohamed El-Erian offers some interesting insights into diversification and risk management in an economic world that is in great flux.
According to El-Erian, the old rules of diversification have changed in a couple different ways. First, with other countries catching up to the U.S., he says investors shouldn’t have as much of their portfolios in U.S. stocks or bonds as they have in the past. U.S. stocks should make up about 15% of an investor’s portfolio, with U.S. bonds accounting for 5%, he says. “We are going toward a world where the U.S. will no longer be the most dynamic part of the global economy,” he said. “Because of the debt excesses of the past few years, it will be a while before the U.S. economy returns to 3% or 4% annual growth. Therefore, the wise investor asks, ‘Where else can I tap into sustainable growth?’ To do that, you need a more global approach.”
In El-Erian’s new asset allocation breakdown, he says stocks from foreign developed markets should account for 15%, stocks from foreign emerging markets 12%, and foreign bonds 9%.
The second big way El-Erian says investors should diversify differently today involves putting a major chunk of your money outside stocks and bonds. These alternative asset classes include real estate (6%), commodities (11%), inflation-protected bonds (5%), infrastructure (5%), and “special opportunities” (5%).
“Don’t become hostage to historical definitions of asset classes,” he says. “Be flexible, because there will be opportunities that don’t fit easily into those [old] categories. … You’re used to facing someone who only throws fastballs and curves. If your mind-set isn’t ready for the fact that you may get a change-up, you’re not going to recognize it.”
One “fat pitch” he sees in today’s market: infrastructure, such as roads, energy production, and water facilities. Investors can tap these investments through exchange-traded funds and mutual funds, El-Erian says. They can invest in commodities in the same way, he adds.
What does El-Erian mean by those “special opportunities”? Currently, they include mortgage securities and debt securities of banks that have received significant assistance from the feds. (El Erian’s buying the bonds issued by the banks, but not their stocks, because the government assistance significantly dilutes their shares, he notes.)
Another interesting point El-Erian makes on diversification: Investors should spread the money not just over different asset classes, but also over different managers. “Beyond a certain point, it’s not more asset classes you need, but more points of view,” he says. “That’s why it’s important to invest with an array of managers.
As for the stock market, El-Erian doesn’t see a big rebound coming soon. With bond yields up in the 8%-12% range, he thinks investors will take those returns rather than taking on the additional risk involved with stocks.
