Sara Silano: Welcome to Morningstar. Today, I'm joined by Nicolò Bragazza, associate portfolio manager at Morningstar Investment Management, to talk about three mistakes to avoid in 2024.
Nicolò, thank you for joining me today. What are the three mistakes that investors should definitely avoid in the new year?
Nicolò Bragazza: So, in 2024, I think investors should look into their portfolios and understand three main things. The first is that cash is great until it isn't. The second is that even if it's true that bonds have provided reliable diversification in the last decade, we should not only rely on bonds for effective diversification. And the third thing is they should be looking into their portfolios and thinking about their portfolios not just in terms of portfolio weights but also in terms of their underlying exposures and sensitivities.
Silano: Let's talk about the first one.
Bragazza: Yes. So, cash is great until it isn't. In the last couple of years, the sharp increase in the interest rates have made cash quite attractive. Until 2021 cash was considered trash for many investors. It is now a more interesting asset class to have in portfolios. And in some geographic areas such as the UK or the US it's now yielding above 5%. And this is with virtually no volatility. So, although there is no doubt that now cash is offering positive real returns, capital security and liquidity; it is important to think about its risks as well, because cash as any other asset, it is not always risk-free. Real yield, capital security and liquidity, all of them should be thought deeply about by investors. Cash returns are short-term and therefore capital security is only for a short period of time. And also, your real yield over the long term may not be a given because the longer is your timeframe, the higher is the risk of holding a sizable amount of cash. In addition to that, cash does not protect during recessions like bonds and therefore its diversification potential is limited.
Silano: And what about the second one?
Bragazza: Yes. So, the second one is do not rely on bonds for effective diversification. As I said at the beginning, bonds have been excellent diversifiers over the last four decades and they provided a reliable source of protection during equity sell-offs. But in a world where we have very high debts, very high deficits all around the world and there is also a need of restructuring our economies, we know that inflation risk is back, and this is the worst environment for bonds. In addition to that, if central banks share this view of an increasing inflation risk, they may not be cutting as much as they did in the past, even during a sharp equity sell-off. And this would limit the ability of bonds to provide effective diversification. Therefore, I think that in response to this quite challenging environment, multi-asset investors need to make use of all the tools at their disposal and also leveraging on the diversification properties of other asset classes such as currencies and alternatives. And with alternatives, I mean specifically liquid hedge funds and gold.
Silano: Finally, what about the third mistake?
Bragazza: So, the third point that I mentioned is: do not think about portfolio weights. Think about exposures and sensitivities. And this is because many people tend to think about their portfolios only in terms of asset weights. And although this is not wrong, it is incomplete. Assets have different sensitivities and therefore the weight may not provide an accurate estimate of the actual risk you are taking. It is important to know your portfolio sensitivities, especially those to equity risk and interest rate risk. These two are called, respectively, the beta and the second one, duration. And an appropriate sizing of both is critical in order to achieve your portfolio objectives.
Silano: Well, Nicolò, thank you very much for coming here today. For Morningstar, I'm Sara Silano.
