Investors have been spoiled by eight years of easy pickings in stock markets but may soon find things are 'bumpier' but also 'more profitable', GMO has warned.
Veteran GMO asset allocation boss and director Ben Inker (pictured) said that many investors had become used to a dangerous combination of backstopped risk and uncapped returns.
'For those investors targeting a given level of volatility, whether through risk parity or otherwise, it has been a license to lever up
their exposures significantly, to generally good results,' he said.
The first quarter of 2018 had offered a lesson in how the more 'normal' investment environment now dawing might work.
'On the other hand, we’ve only started the transition from easy to hard, and that path is, almost by definition, not a pleasant one.
'"Hard" is, well, hard, and it’s hard to like things that are hard. Personally,I’m hoping for a return to hard. Not only should it lead to better long-term returns to investors, but it is also a good deal more interesting.
'In reality we’re faced with a dilemma: either risk has fallen alongside risk premiums, or we are seeing an end to historically low volatility and bond-equity correlations.'
He added that both his literal and figurative money was on the latter eventuality and that 'stability breeds instability' as the complacency of easy returns to higher gearing would inevitability lead to a build-up of liabilities.
Contrasting the last three month with the last five years, Inker noted that annualised volatility for the S&P 500 was 19% and bond-equity correlations varied from -0.2 to +0.1.
‘Last quarter looked a lot more like the average conditions investors have experienced over the last 150 years.
‘The trouble is that markets today, particularly US markets, aren’t priced for that world, so if current conditions persist, I believe valuations are likely to fall.’
But he doesn’t see this as a bad thing.
‘Easy may be more fun in the short run, but give me harder and more profitable any day of the week.’