Trevor Williams
The 60/40 portfolio has been an investment staple for decades. David Picton, President and CEO of Picton Mahoney Asset Management, explains why investors should consider looking beyond traditional asset mixes in today’s trading environment.
Transcript
Greg Bonnell – As central banks hiked rates aggressively in the attempt to tame inflation, some investors began questioning whether the 60/40 portfolio is still a valid strategy. Well, our featured guest today says investors may want to look beyond that traditional asset mix in today’s environment. Joining us now to discuss is David Picton, President and CEO of Picton Mahoney Asset Management. David, great to have you on the show for your first time.
David Picton – Pleasure to be here.
Greg Bonnell – Since it is your first time, we’ll introduce you to the audience. Tell us a little bit about your firm and what your philosophy is.
David Picton – We’re coming up on our 20th anniversary. We’re at approximately $11 billion or so of money, very much with a focus on alternative investments. We’re trying to provide differentiated return streams for our end investors.
Greg Bonnell – All right. So alternative investments, let’s try to get into that. Because obviously, as I was saying in the introduction, people for a long time have taken a look at the 60/40 portfolio and whether they made it 70/30 or whatever, but sort of saw that as a framework. That was definitely put to the test coming out of the pandemic with rising interest rates. What do we need to be thinking about?
David Picton – We like to view these different asset classes as simply return streams. Stocks go up over time approximately 7% or 8%. Bonds go up approximately 5% or 6%. And sometimes their returns act differently from each other. And so when you combine those two assets together, especially over the past 40 years, you’ve had a wonderful experience investing in markets.
Interest rates came down. And every time there was a hiccup in the stock market, the bond market rallied. And you had an overall pretty good return out of the whole strategy until we hit a new inflationary regime. And as we saw in 2022, those for the first time in years where both of those asset classes not only underperformed, they underperformed significantly and at the same time. And it was the first time that many investors felt some sticker shock when they opened up their statements because not one of the assets helped offset the other.
Well, what we try and do is take that idea of assets offsetting each other and bring it into the alternative space. So if stocks and bonds are somewhat correlated, if we could have another asset class that is completely unrelated to what’s happening in the stock and the bond market, we think if you add that in, and it has a positive return stream over time, you now get a diversification benefit, and you get a way better risk-adjusted return for your end investor.
Greg Bonnell – Does that take us into what we call market neutral as being an important category here?
David Picton – Market neutral or alpha generating strategies are a very important part of this. So, for instance, when you buy the stock market, you are essentially buying beta. If the stock market goes up, your mutual fund generally goes up about the same, plus or minus a little bit. If the bond market goes up, your mutual fund in the bond market goes up, plus or minus what the bond market is doing.
So what we want to have is build something that is not focused on either of those two betas, and instead focuses on company-specific drivers to generate a return regardless of what’s happening in the stock or the bond market. And market neutral fits right into that category.
Greg Bonnell – Let’s dive a little deeper into that. What does that mean, then? How do you build that kind of portfolio?
David Picton – You’re looking for isolating the performance of companies. And so to do that, you have to find companies you like. At our firm, we focus on positive change, good value, fundamentally positive change and quality. And then you try and offset that company’s market exposure by adding in shorts into the list.
So we like companies with positive change, good value, and high quality. We really dislike companies with negative change, poor value, and poor quality. So if we can build a basket of these negative change companies that we then short, i.e., sell without owning, we can then hedge out all of the market risk of the things we like. And we end up basically with just stock-specific alpha left within the portfolio.
Greg Bonnell – Now, is a strategy like that something that starts to work in concert with a 60/40, with the traditional mix of equities and bonds? Is that old strategy completely being pushed out, or are you sort of doing a mix of things?
David Picton – Yeah, we never push those out. Because if you look in the very, very long run, you would like to have stock or beta in your portfolio. You’d like to have interest rate sensitivity yield in your portfolio. And in the very long run, all studies will show those are important building blocks for your mix.
But having only two options in your portfolio is kind of like going to play golf and you’ve got a driver and a 2-iron. Okay, well, what about my wedges and my putter? How do I fit all that into the mix? So we want to add in new tools. So the key to all of this is that you have to have a return stream that’s positive. And it has to act differently from your stock and bond portfolio. That’s now when you start to get a smoother ride along the way and better risk-adjusted returns.
Greg Bonnell – All right. Let’s talk about risk management as well. It sounds like part of the overall strategy is thinking about that kind of risk, particularly in that inflationary regime, where we saw both asset classes in 2022 get hit very hard.
David Picton – Huge focus for any alternative manager is risk control. We spend as much time almost on risk control as we do on the stock selection part of the portfolio. And we do that in a number of different ways. We have portfolios that are meant to be related to the market, half-related to the market, or zero related to the market, in the case of market neutral. So you always have to have your risk processes, making sure that when you say you’re going to be not related to the market, you are not related to the market. And we’ve done a very good job of that in the long run.
And then, secondly, you augment maybe certain market exposures. For instance, in an environment like today where things might be a little bit heady and valuations and options are lower, you might add in extra option protection into the mix. And then, finally, within market neutral, you generally don’t take massive sector bets.
Sure, we might like copper or gold. But you don’t build a copper and gold portfolio and then hedge it all out with your technology and bank portfolio. You want to make sure that you’re kind of constrained in the amount of risk you take within the sectors as well.
Greg Bonnell – What do you think about the current market environment right now? It’s sort of interesting times. We had bond yields push up through the fall, ease back off. We entered this year thinking this is the year of Fed rate cuts. And we’re finally getting readjusted from all the dislocations of the pandemic, and it really hasn’t played out that way yet.
David Picton – Well, we’re happy to say that Jamie Dimon from JPMorgan stole one of our taglines, and that is that we are cautiously pessimistic. In other words, we’ve had a nice move up in risk assets, especially in the equity market. And, sure, technology’s driven it. But there’s been a lot of good movement across all sectors over the last six or eight months.
At the same time, we’ve had interest rates backing up. And at the same time, we’ve pushed out expectations for rate cuts. So the market is factoring in a lot of good news. It’s factoring in lots of growth. It’s factoring in interest rate cuts coming. It’s factoring in inflation easing off. And it’s paying a multiple for that well above what we’ve seen in the past. So while we kind of can see how it might work out, there’re some probabilities that it don’t work out, and then hence our cautiously pessimistic tone as we approach it today.
