Nick Samouilhan, multi-asset manager at Aviva Investors, learns some strategic lessons from the US Fed’s summer “QE Drill”
Every Friday at 10:00am, the Aviva Investors building at One Poultry has a fire-drill, with overhead sirens erupting across the floors. This ear piercing exercise dates back at least to when I was first interviewing here three years ago, with my prospective boss simply talking louder as the sirens started. (This singular disregard for what I thought was a relatively serious warning in order to continue going through my CV line by line did cause me to briefly question whether this was a safe career move or not).
But, while irritating, the regular alarm does play an important role – ensuring that, in the event of an actual fire, we’ll all know what to do. Or at least, we’ll know what the fire-alarm actually sounds like. Knowing it is coming, however, we all ignore it having quickly learnt the main practical lessons:
• Don’t ask across the table for tea orders leading into it;
• Avoid being anywhere near the building if you have a headache; and
• Don’t take any phone calls after 9:55.
Light With Taper and Retire
Not being a member of the US Fed, I don’t know whether or not they have a similar difficulty with ceiling based alarms every Friday. However, back in June this year the Fed gave the market its very own “QE-drill”, where it announced (but didn’t begin, it was only a drill) to scale back part of its asset purchasing programme. Now, months later, as we look forward to its looming introduction in the next few weeks, it’s important not to forget the lessons that this QE-drill taught us about how markets can, and could, react to it.
Having provided what we think are the correct lessons on how to deal with the internal Aviva fire alarm (“no calls after 9:55” being perhaps the most important), here are the two main, and similarly straightforward, lessons from the Fed’s “QE drill” that we think should be kept in mind over the next few weeks.
The first lesson to take from June’s “QE-drill” is that the main assets impacted by an end to QE are likely to be the same assets that benefited the most from it. I understand that this seems about as insightful as “don’t answer the phone just before the alarm time”, but it doesn’t need to be insightful in order to matter. This means that we should be wary of chasing yield in the portfolios going forward, because that will lead us into those asset classes that were the biggest beneficiaries of QE – and therefore, the most vulnerable to the ending of it.
The second lesson is that, when diversifying a multi-asset portfolio, attention should be paid not to the historical correlations between asset classes, but rather to their actual underlying drivers. Drivers of asset classes change, and it is these drivers that you are diversifying with, not the actual asset classes.
During this fire-drill, however, both fell – negating any perceived diversification effect. The reason was that the dominant drivers of these two asset classes went from being market sentiment (where they were impacted in opposite ways) to policy support (where they were impacted in the exact same way). For all the short term impact on our portfolios, the tapering drill in June was a very useful lesson about how the market could behave as tapering occurs, and these lessons should not be easily forgotten.