This is part of an ongoing series of articles published by Johnson Financial Group. This issue is written by Brian Andrew, EVP, Chief Investment Officer.
Every year, Milwaukee, Wisconsin, plays host to the world's largest music festival. Over the course of 11 days, 800 bands will play at the lakefront Summerfest grounds. The lineup was announced today! As a music fan, I can appreciate the opportunity to relive the '70s ‐ '90s as well as hear new acts. In one stroll through the park, you can hear pop, rock, country, blues, hip hop and more. The diversity is incredible. It reminds me of the importance of diversity in an investment portfolio.
With the announcement of the Summerfest talent schedule comes the list of nightly headliners. These are the main stage acts everyone wants to see. This year's list includes Jason Aldean, Jennifer Lopez, Lil Wayne and Snoop Dogg (it has taken me years to get “Snoop Dogg” into an investment commentary). That's a diverse representation of music genres and talent.
Portfolio headliners should include the asset classes you have exposure to. In our case, we define them globally and include stocks, bonds, cash and complementary investments (such as real estate, commodities, infrastructure, private equity and credit, and hedge funds). We know that each of these asset classes performs differently throughout a market cycle and reacts differently to global macro issues surrounding politics, trade and economic growth. They do because they represent different areas of a company's capital structure. What is good for bond holders isn't always good for stock holders and vice versa.
Within these major asset classes are sub‐categories. For example, within the stock class we include stocks in the U.S., internationally, and from emerging markets, as well as stocks that have growth and value characteristics. The bond asset class includes Treasuries (government bonds), corporate credit (both investment grade and high yield), mortgages and other asset‐backed securities, and a few others.
Each year we review our expectations (capital market assumptions, or CMAs) for the performance and volatility of each of these headliner asset classes and their sub‐categories.
We use this information to update clients' financial plans, set expectations for future returns and determine how each client's portfolio should be allocated among them. As an example, our CMAs for U.S. stocks show that expected returns over the next 10 to 15 years are 6.3%. For international stocks, we are expecting 7.9%
You might note that these expected stock returns are well below the long‐term average, which is near 10%. Not surprising, given the fact that we've seen tremendous growth in stocks over the last decade. Bond returns are muted as well. Our CMAs for bonds in general is 3.9%. This is a function of how low interest rates are and our view that they will remain low for some time.
Despite these lower expectations and because we believe that inflation will remain tame, we believe that these headliners have a place in portfolios. However, we favor being underweight fixed income so we can add money to those alternative investments that may act like bonds and provide a better return.
Because we have an expectation that returns will be muted in these traditional headliner categories, we need to look beyond them for opportunity.
At Summerfest, there are countless “Ground Stage” acts providing an opportunity for the more educated and esoteric musical palette. This year acts such as Steve Aoki, Walk the Moon, Lizzo and Chaka Khan will be providing entertainment here.
Portfolio ground stage acts include those investments that provide a different form of return or perform differently in the market cycle than the headliner acts. These might include private equity and credit, infrastructure, hedge funds (such as those strategies that are invested both long and short equity or using global macro strategies). Because these investments act differently during the cycle and to global macroeconomic events, they provide both diversity and a different source of returns. We use them to complement the headliners and round out our portfolio construction.
If you're into music, you may want to see some local acts, old and new, on some of the smaller stages. In your portfolio, these small stage acts might be thematic investments that fit your risk profile, express a view you have because of your personal expertise (just like those local bands you know of) or represent your desire to make a difference with your investments. While not a significant part of the portfolio, like your Summerfest experience, you will appreciate having them around because they round out your total experience.
Like any good day at Summerfest, it takes all of these to make up the whole experience. Our portfolio management team understands this concept when constructing portfolios of investments that meet the specific needs of our clients. With this in mind, we select from index and active strategies representing all of these categories to provide a holistic approach to create the solutions that meet each client's unique needs and desires.
You'll know where to find me in June!
This information is for educational and illustrative purposes only and should not be used or construed as financial advice, an offer to sell, a solicitation, an offer to buy or a recommendation for any security. Opinions expressed herein are as of the date of this report and do not necessarily represent the views of Johnson Financial Group and/or its affiliates. Johnson Financial Group and/or its affiliates may issue reports or have opinions that are inconsistent with this report. Johnson Financial Group and/or its affiliates do not warrant the accuracy or completeness of information contained herein. Such information is subject to change without notice and is not intended to influence your investment decisions. Johnson Financial Group and/or its affiliates do not provide legal or tax advice to clients. You should review your particular circumstances with your independent legal and tax advisors. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your taxes are prepared. Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Asset allocation and diversification do not assure or guarantee better performance and cannot eliminate the risk of investment losses. Certain investments, like real estate, equity investments and fixed income securities, carry a certain degree of risk and may not be suitable for all investors. An investor could lose all or a substantial amount of his or her investment. Johnson Financial Group is the parent company of Johnson Bank, Johnson Wealth Inc. and Johnson Insurance Services LLC. NOT FDIC INSURED * NO BANK GUARANTEE * MAY LOSE VALUE