Adding a dynamic allocation that can adapt to the changing environment

As I think about the outlook for the global economy and financial markets in the year ahead I can’t help but bring it back to a sporting context, in my case football. In preparation for every football match a manager sets out his team and tactics to win the match, his game plan. As good as that game plan may be no manager can legislate for how the game will actually evolve. One mistimed tackle here or one poor pass there can change the game, just as a poor refereeing decision, what economists might call an ‘exogenous factor’, can put the best laid plans out the window. Still, the best managers set out their team to be able to adapt to anything that comes at them.

It is no different in the financial ecosystem in which we operate. We do not live in a static world, even the most sophisticated economic and financial models have their limitations. We are all part of the very world we try to model and ultimately, as human beings, we are not always rational despite what these models might assume. As investors, while a significant amount of what actually happens is outside our control, there is still a strong case for a well thought-out plan, the foundation of which is realistic expectations of risk and return.

Ultimately, the more robust the investment strategy the more adaptive it can be to the circumstances of the environment that prevails and hence the higher the probability of success. Over the last five years investors have been well served by a long term strategic asset allocation, ignoring short term fluctuations, as equities and bonds moved higher. However, with many of the major equity indices now at record highs and bond yields at or near record lows, there is a strong case for adding a dynamic element to portfolios that can adapt to the changing environment.

The volatility that we have seen over the last few weeks points to a market that is finding it more difficult to appraise the consequences of divergent monetary policy, the oil price collapse, a lower growth environment and, most concerning, the risk of Europe becoming mired in deflation. Whether it is life, football, business or investing it is the ability to adapt to a changing environment that is at the very heart of our survival.

On that note, I’ll leave you with a quote from the self-proclaimed ‘special one’:

“In this moment our team are able to adapt to everything. What the game gives us, we can cope with. We are not the kind of team that play only the same way, think the same things. We can play in a different way and adapt to different situations.” Jose Mourinho, Chelsea FC Manager, October 2014