View full transcript
LARS SCHUSTER: Somewhere around the world, every day, something's going to be happening. It's how we choose to react to it as investors that will really dictate our future financial success.
[MUSIC]
JIM ARMSTRONG: Lars, when headlines are dominated by geopolitical tensions in the Middle East, rising oil prices, concerns about inflation, I recognize you can't build a portfolio that's completely unaffected from the world around us. But at the same time, I think I'm looking for some thoughts about how to build something that can help weather the risk.
LARS: Yeah, this is a challenge investors have faced for decades and decades. There's always something going on around the world. So in my view, trying to build a portfolio with some durability to it, and that might include a strategic mix of assets, things like US stocks, international stocks, bonds, that map to a financial plan and then just sticking to that mix. That sounds very simple, but it's very hard to do because, like you said, there are things going on around the world and it makes us feel like we're supposed to do something more and different. And so maybe layering in some doses of small investment diversifiers can build additional portfolio resiliency over time. And it's really the combination of the strategic mix with these diversifiers that can help us prepare for, not predict, the changing market environments that we all go through.
JIM: And it's those diversifiers that I want to talk to you about today. What should people invest in that can at least help to manage risk?
LARS: The one that comes to mind first and foremost to me is commodities. Commodities is in this broad category made up of, really, three different things, energy, metals, and agriculture. So maybe we'll just take a couple of those. If you look at energy, this year, we've seen spiking oil prices because of the geopolitical conflict in the Middle East, and that's been a valuable diversifier to have some oil and gas in a portfolio. We saw something similar in 2022. Now, if you look at the metals side, take something like precious metals, gold, that traditionally has done quite well when there's uncertainty around the globe, when inflation is firmer. So you think about oil, you think about precious metals like gold, historically, they move in different directions from traditional stocks and bonds. And that's the whole point. They're a diversifying element to a portfolio, but a little can go a long way, because they can be volatile. So having them as a complement and not a core holding in a portfolio might be a good way of thinking about it.
JIM: Now I know everybody's situation is, by definition, going to be different, but what percentage of somebody's portfolio would you say might be allocated to a commodity?
LARS: All right, let's take just maybe a broad, simple 60/40 portfolio, 60% stocks, 40% bonds. The investment team that I'm a part of here at Fidelity, one way we think about it is about 6% or so in these additional diversifiers right now, and of that, it's really 1% in commodities. Because, like I said, it can be pretty volatile. A little can go a long way.
JIM: Rising oil prices increase the cost of everything across the board, not just gas. With that in mind, how can we manage inflation?
LARS: Well, you're right. Oil and gas prices feed into a whole spectrum of different things. And so firming inflation is something real, is something to prepare for and watch. Commodities can be helpful in that situation. But if we think about the other end of the risk spectrum from commodities, there's these things called TIPS, Treasury Inflation Protected Securities. They are a US Treasury bond, but they come with this unique feature where the value is adjusted when inflation is firming or going up. And so from that perspective, they help manage the inflation risks for bonds. And it's really, TIPS are a risk management tool for the bond portion of a diversified portfolio.
JIM: I want to also ask you about something I've been hearing a lot about, liquid alternatives. So two questions, first, what are liquid alts? And then second, how might they fit into a portfolio through that risk management lens?
LARS: Yeah, there's been a lot of press around alternatives and liquid alternatives, and they come with all these esoteric-sounding names. But they're really just kind of this hodgepodge of different trading strategies and options and derivatives. And what makes them liquid is that they price every day, and you can buy them in vehicles like ETFs and mutual funds on a day-to-day basis. But they’re very differentiated risk and return parameters from traditional stocks and bonds. And that can be helpful in periods of uncertainty or market volatility, like we've seen at points this year, but also when inflation is warming. Because inflation can be a challenge. It's troublesome to bonds. And so they're an extra diversifier. But just like commodities, just like TIPS, liquid alternatives, they're a complement. JIM: All right, one more potential diversifier I want to squeeze in, high-yield bonds.
LARS: Yeah, so high-yield's on the different area of the risk spectrum from, like, TIPS. And high-yield actually can be beneficial if the economy is growing, market volatility is eased, fundamentals of corporations are good, but inflation is warmer. And part of the reason is because inflation can be troublesome to high quality bonds. And high-yield bonds come with higher yields, but they also come with higher risk. But there are some things going on over the last several years that may be beneficial or provide some optimism. One, in the high yield bond, category, it's tilted up in quality. There's more BB-rated and less CCC-rated bonds than 20 years ago. Two, default rate expectations today are less than long-term averages. And then thirdly, is just the overall mix of the category from a composition perspective or sector. There's more energy and less technology. So from that element, it provides some diversification to that portfolio, particularly high quality bonds. And so if we think about all of these things together, it really provides that additional resiliency given the changing market environments that we're going through.
JIM: Lars, to recap, you have talked about commodities, TIPS, liquid alts, and high-yield bonds, all as potential ways to build some diversification into your portfolio. But the hope is that you can build something that can help you manage potential risk.
LARS: That's what it's all about. It's durability. Because none of us know exactly what the future holds. If we did, we wouldn't have all this stuff. We would just have one asset class. But because we don't know what the future holds, we're trying to build resiliency and durability that helps us stay invested. And one of the best ways we can do that is to have diversification that maps to your goals, that helps you sleep at night.
JIM: Got it. All right, Lars, thank you so much. If you would like to schedule an appointment to talk about your asset allocation, Fidelity has tons of resources to do exactly just that. You can start off by heading to Fidelity.com/ManagedAccounts and take a quiz and get started there. Thanks for watching Fidelity Viewpoints.