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Rob Arnott on All Asset January 2016

JP Osseward
February 9, 2016

Rob Arnott, head of Research Affiliates, shares his firm’s market insights and allocation strategies for PIMCO All Asset strategies.

Q: At the start of each year, we would like to begin with a discussion of your outlook across all global asset classes. As you look across the broad opportunity set, what are your return expectations and where are you finding opportunities for attractive return?Robert Arnott: Past is not prologue. As investors, we want to buy low and sell high, which is easy to say and very hard to do. Whatever is cheap became cheap by treating us badly; whatever is overvalued, and poised to perform badly, got there by treating us very well. This is why successful investing requires that we regularly inflict pain on ourselves. George Soros famously said, “successful investing is very painful.”

There’s a famous Wall Street adage, “never mistake a bull market for genius, or a bear market for stupidity.” Past performance fools us twice. Great performance feels wonderful, even as a stock, a sector or an asset class is getting repriced for much lower future returns. Lousy performance inflicts pain, even as a stock, sector or asset class is getting cheap and is priced to deliver superior returns.

It’s a natural human tendency to forecast the future by extrapolating the recent past. This is the reason people chase performance, which is, in turn, the root source of the most grievous errors in investing. Russ Kinnel, in his seminal 2005 white paper, “Mind the Gap,” found that the average investor forfeits 2.8% per annum by trend chasing, buying what’s hot and selling what’s not.

Money was pouring into the All Asset suite in late 2012 and early 2013, when a bull market in “third pillar” assets meant that even the third pillar was fully priced. Now, after a grinding three-year bear market in our core asset classes – which tends to make those asset classes cheaper, and potentially positions them for terrific current yield and strong long-term future performance – we see meaningful outflows. It’s sad to see our own contratrading against markets cancelled by client trend-following.

This is why – after a three-year bear market in “third pillar” assets, a period of unusually intense pain – my confidence in the future performance of our strategies grows. We do our clients a grave disservice by flinching, as so many investors do, and abandoning our discipline, our process, and our principles in the face of a daunting three-year bear market in our core asset classes. Our clients may flinch, but we will not. We will increase allocations to whatever has become very cheap.

We believe there is value in objectively measuring asset class return expectations. As with most managers, we have no clairvoyant ability to pick tops and bottoms with precision. But, we can forecast long-term returns with surprising efficacy. Anyone can! We fully recognize that our expectations are imperfect and that we have no crystal ball for the future. As Yogi Berra famously remarked, “It’s tough to make predictions, especially about the future.” We evaluate long-term return expectations – not for the purpose of anticipating short-term price movements – but rather for assessing comparative valuation levels across a panoply of global markets and gauging when they are most at odds with market perception.

Our assessment of forward-looking returns is an essential component of the All Asset strategies. Our models give us an objective reason to buy assets after they’ve cratered, when nobody wants to own them, and to sell assets that have lofted to new highs and are basking in popularity. Ironically, the more uncomfortable a trade is, the more confidence we can have that it’s likely to be profitable in the intermediate term, rather than just long-term. This approach goes directly against human nature and is one of the elements required for successful, long-term contrarian investing, which I have practiced for over three decades.