Lawrence Jones: Hi I’m Lawrence Jones, Associate Director of Fund Analysis for Morningstar and I have the pleasure today of speaking to Robert Arnott who is a founder and chairman of Research Affiliates, and also Manager of PIMCO All Asset and PIMCO All Asset All Authority. Robert, thank you very much for joining us.
Robert Arnott: Sure, it’s my privilege. Thank you.
Lawrence Jones: One of the questions I know is on our investors line most involves asset allocation and in particular in 2008 I think a lot of investors felt that their asset allocations at least the way they traditionally thought about them pairing bonds with stocks and then attempt to medicate volatility seem to kind of fail them or at least their expectations were perhaps unrealistic. If you can talk a little bit about your thoughts about diversification are going forward and how you think that best achieved. That will be a great start.
Robert Arnott: Sure, I think the lessons of 2008 are several fold. One of the lessons is the old notion of starts for the long run shapes the way a lot of investors think about investing. They put most of their money in stocks and the simple fact is the stocks once in a while come around and hit us pretty hard.
So the notion of learning from 2008 not to exceed our risk tolerance I think it’s awfully important. Charlie Elysees adage that rule number one in investing is don’t lose, rule number two is zero number one. Also comes in to play if you’re down 10% and then the 11% gain to make it back. Not too big a deal. If you’re down 20 you need 25. That’s getting a little tougher. If you’re down 50 you need a hundred. And 2008 brought that home vividly.
There’s another adage on Wall Street which is that in a market crash, the only thing that goes up is correlation. We saw that in speeds in 2008. It’s a reminder again not to take more risks than we’re prepared to weather. To be invested in stocks, lose half your money and then get out is a disaster.
If you go in knowing that that could happen and riding it through you would even know what it may take several years. If it is an acceptable risk to see that down side okay, but you have to be willing to take the risk that you’re taking before you go into it. And that’s a wonderful lesson of ‘08 and a very, very painful one.
As for correlations, they do soar in market crashes. In a market crash you have a flight to quality, a flight to liquidity and a flight away from unfamiliarity.
So anything that has a quality spread that has liquidity issues or it has unfamiliarity is going to plan. Well, guess what? That covers most of the market falls into one of those categories but the only thing that doesn’t is treasury bonds and that was the only thing that was up materially last year.
So one easy lesson of 2008 is to say “Gosh, I shouldn’t count on diversification. I should take much less risks.” That’s a wrong lesson. That’s a very bad lesson to take away from LA because what we saw in 08 is probably a once in a career experience and so to draw from a once in a career experience a lesson that you won’t need again in your career. It’s actually dangerous.
I think the correct response to this environment is actually to stop up your risk. If you weren’t already taking too much risks to begin to nibble away an incremental risk and take advantage of some other really rich opportunities that are out there.
Lawrence Jones: Thank you very much for joining us today.
Robert Arnott: Thank you for your time.
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