Rob Arnott: Investors Should Consider A Cheap Diversifiers Strategy

In his recent interview with WealthTrack, Rob Arnott explained why investors should consider a cheap diversifiers strategy. Here’s an excerpt from the interview:

Arnott: Basically, my view was people have lots of money in mainstream stocks, lots of money in mainstream bonds, everything else, what I call the third pillar of investing, strategies that are diversifying away from mainstream stocks.

Strategies that have their own independent source of incremental return. Strategies that can protect against inflation, which mainstream stocks and bonds obviously this year can’t.

Why don’t we think in terms of creating a strategy that fills a robust third pillar, a one-stop shop for liquid alternative markets, a one-stop shop for reliable real returns and real income.

The strategy was launched. I was invited to be the sub-advisor. To this day, I think I’m the only subadvisor they’ve ever had. I consider that a real honor and a privilege.

Host: Right. Good for PIMCO, too.

Arnott: We’ve achieved the CPI plus 5 targets 70% of the time since the launch of the strategy, which is good. The thing that’s interesting is when we don’t achieve it. This year, we haven’t achieved it. Big time. When you have a take-no-prisoners market crash, everything craters including inflation hedges. I mean…

Host: No, just about everything’s been hit.

Arnott: Exactly. And commodities since March. And when you get take-no-prisoners market crash, everything goes down. And then the market does a sorting out process asking, “Okay, is this now cheap? Is that now cheap?”

We’ve seen this again and again, when the diversifiers crater, the snap back can be stupendous. I’m cautiously optimistic that we’ll see a snap back that’ll surprise investors. I hope I’m right on that.

One of the issues in the 2010s is that you had a relentless bull market in stocks. Relentless bull market in growth stocks in particular.

So diversifiers… A friend of mine likes to say that diversification is a regret maximizing strategy. In a bull market, you regret every penny you put in diversifiers. In a choppy sideways market or an inflationary market, you wish you had a lot more in diversifiers.

Inflation expectations are still anchored in the low two’s, break even inflation on a tenure basis, which is the gap between treasury bond yields and inflation linked bond yields on a tenure basis is 2.3, with 9% trailing inflation. That’s astonishing.

Host: It is astonishing.

Arnott: If inflation expectations start to ratchet higher, these diversifiers can be a wonderful island of serenity in markets that are likely to be royaled.

You can watch the entire discussion here: