It is understandable that today's uncertain economy and volatile markets may leave clients feeling immobilized.

And most set-it-and-forget-it strategies are no match for the current wide range of potential market outcomes in 2012. As we embark on a new year, it may be prudent to consider three different absolute return portfolio strategies that may help achieve returns depending on one's outlook for the global economy.

At the beginning of 2011, the recovery from the financial crisis seemed to be slowly gaining momentum, with U.S. growth surprisingly strong during the first quarter. Then a number of hurdles appeared. The March earthquake and tsunami in Japan had a negative impact on global manufacturing. Uprisings in Africa and the Middle East contributed to a short-term spike in oil prices in the spring. The U.S. Congress found itself embroiled in a debt ceiling debate over the summer, which was followed by a downgrade in the U.S. credit rating in August. And, of course, the sovereign debt crisis in Europe continued to threaten world economic recovery throughout the year.

The first two of these hurdles have now been overcome from a market perspective. The debt issue in the U.S. remains unresolved, and China, the primary engine of global growth, is now showing signs of a slowdown. But from where we sit now, we believe the situation in Europe is by far the most significant threat to the global recovery. As we begin 2012, we see that the path Europe takes to solve its crises will likely dramatically impact the economy and markets globally. In particular, how the rescue package and the key political and economic leaders in Eurozone are perceived by the market will be critical.

As of this writing, the European Central Bank's (ECB) expanded role in fighting the European sovereign debt crisis has been focused on buying time for local governments by purchasing their debt. The ECB's immediate goal is to lower yields to help individual countries refinance their debt coming due at a manageable cost.

There are very large tranches of sovereign debt that must be refinanced in early spring in Italy and in other Eurozone countries. If yields are extremely high at that time, the world economy will be extremely vulnerable to a negative jolt. So timing is very important.

While the ECB's purchases to date have had the desired effect of alleviating some market stress, they only serve to buy time while key parties continue to develop a long-term solution. For example, the ECB's role may be expanded to include interventions similar to those undertaken by the Federal Reserve in the U.S., and in return the ECB would likely demand more direct fiscal control over the local economies.

The stakes are high, and no one can predict with certainty how the European debt crisis will play out. In this context, we suggest three options for absolute return allocations depending on one's outlook.

One approach, for investors who are confident that a European solution will be found soon, is to position a portfolio with a larger "risk-on" bias.

This type of absolute return strategy may include some equities, although it may also hold minimal equity hedges such as inverse exchange-traded funds and equity put options.

In the bond portion of the strategy, which would likely be the largest share of the absolute return portfolio, a mixture of corporate and Treasury bonds may be desirable, with a greater weight on corporate bonds because high-grade corporate fixed-income is likely to outperform Treasuries in a risk-taking environment, in our opinion.

A second approach, for those investors who believe that the European situation will likely deteriorate, is to avoid any exposure to equities. These investors may want to make a sizeable allocation to Treasuries with a significantly smaller investment-grade corporate bond position. This configuration would take advantage of the ultimate flight-to-quality holding in fixed-income during such a scenario—U.S. Treasuries.

For both of the above strategies, one's outlook needs to be proven correct for the portfolio to do well. If the European crisis significantly improves, the "risk-off" portfolio may be expected to perform poorly. And those "risk-off" portfolios with longer average durations would experience more dramatic losses than those with shorter durations should yields rise.

For example, if the average duration of the portfolio were six years and Treasury yields rose 150 basis points, an investor could incur a loss up to 9% on the Treasury investments.

The "risk-on" portfolio would likely perform strongly if the European crisis is satisfactorily addressed, with equities achieving attractive results and corporate fixed income likely to add some value.

In the opposite outcome, if the European crisis continues to spread, the conservative portfolio may be expected to perform better, but this approach's potential gains may be somewhat muted because Treasury yields are already so low.

There is a third option for those who want to position their portfolios defensively and yet still leave the door open for positive return opportunities.

Investors may prepare for either outcome in Europe with an absolute return portfolio that essentially creates an inexpensive put option on the European debt crisis. This strategy would emphasize fixed-income holdings, with a mix of Treasuries and investment-grade corporate bonds, so that the bond allocation would not be dependent on one outcome. A smaller exposure to equities would be coupled with both equity and volatility hedges because volatility hedges may protect the portfolio from equity losses without removing the opportunity for upside gain if stocks rise.

This third option is designed to allow investors to exert greater control over their outcome, whether the European crisis resolves or worsens.

And because adjusting hedges is relatively easy and inexpensive, this approach also allows investors to easily and quickly adjust their positioning once the outcome in Europe becomes more certain.

In today's unsettled world, perhaps the best strategy is to prepare for both the best and the worst possibilities in 2012.

Ted Wright, CFA, is director of portfolio management for Genworth Financial Asset Management. He oversees asset allocations for the firm's investment solutions.

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