Global Macro and Institutions

March 2011 » White funds? Bonds or bond paper Why Why fund might be the better choice a bond Global Macro strategies for most clients can help institutions

Jason R. Vaillancourt, CFA Portfolio Manager, Investment Strategist, Putnam Global Asset Allocation Group

Key takeaways

• Rising correlations pose a

challenge to institutions trying to find beneficial portfolio diversification.

• The loss of diversification

opportunities can be measured across equity styles and asset classes.

As we begin the second decade of the 21st century, institutional investors are faced with many challenges. The quarter-century-long bond bull market may be drawing to an end. The residual effects of the 2008 financial crisis have investors questioning the benefits of illiquid asset premiums. Strong market returns in 2010, the year of the “risk-on, risk-off” trade and historically high correlations within asset classes, reinforced another lingering challenge for plan sponsors — namely, how to find uncorrelated sources of return. At Putnam, we believe institutional investors can respond to these challenges by considering the merits of Global Macro strategies, which offer a powerful tool for better diversification. The recent popular “risk-on, risk-off” catch phrase leads one to think that sky-high correlations are a recent phenomenon, perhaps exacerbated by the financial crises. Indeed, the recent experience has certainly been of historic proportions; however, the attention paid to correlations in the past two years masks an important fact. The reality is that equity correlations have been increasing steadily for the past 20 years (Figure 1)! Simply increasing allocations to core international equity and emerging-market equity does not provide the diversification benefit that it once did. In this paper, we will explore why correlations have been increasing, quantify the loss in diversification benefit over time, and discuss how plans can make up for this loss in diversification by adding...