As the Federal Reserve prepares to cut interest rates, financial experts provide advice on how investors can position their portfolios to capitalize in an evolving economic scenario. From reimagining equity approaches to improving bond exposures, this piece offers a roadmap for success in the year ahead.
Riding the Small-Cap Wave
Interest rates continue to decrease, leading many experts to believe that the market conditions are in favor of small-cap companies. The small-cap Russ 2000 index has gained 2.1% on the week, beating the S&P 500’s move up 1.4%, observed Jon Maier, chief ETF strategist at J.P. Morgan Asset Management.
This stands to reason since small-caps stand more to gain from a period of low borrowing rates given most (if not all) small caps typically have some debt on their balance sheets which they rely on in order to grow. That could allow these smaller companies to take advantage of the low interest rate environment and deliver better returns for investors with the Fed making noises about easing monetary policy.
And by turning some of their equity allocation over to small-cap ETFs or funds, investors may be able to put themselves in a position to benefit from outsized gains in small caps next year. This approach can serve to help diversify risk and improve total portfolio returns in a low rate environment.
Cash and Bond Strategy Rethink
With the aforementioned equity repositioning, experts also suggest that investors look at changes in their cash and fixed-income allocations. Maier says that the average return on the top 100 money market funds are well above 5%, but that is expected to change.
From our perspective, fixed income is just seeing a flow environment right now because of rates, and I’m sure that will continue,” Maier said. With rates on the way back down he is looking for some of the trillions of dollars parked in money market funds to move into bonds.
Investors may wish to reduce the size of a cash holding and reinvest it in longer-dated fixed income instruments such as government or high-quality corporate bonds. Now the bond market can claw back some of its lost potential upside as yields adapt to a higher-rate environment.
And please never forget that PART OF REAL RETURNS CAN COME FROM INTELLECTUAL DURATION …..and may be about to change due to the Fed’s response function. Shorter-maturity bonds may have less risk to rising interest rates, and investment-grade bonds do offer an additional layer of predictability and income in a potentially weaker economy.
Conclusion
With the Federal Reserve walking a fine tightrope between maintaining economic growth and controlling inflation, investors need to be vigilant in allocating their portfolios accordingly. Given the changing sands, taking a nimble and guarded approach to the markets — with concentrations in small-cap equities and calibrated cash and bond exposure — could allow investors to stay afloat as well as find pockets of inflation protection in today’s low-rate world. In following the counsel of some financial experts, investors can generate portfolios that are both durable and malleable enough to survive in the coming year.
