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USD depreciation risk | Can you be "too" diversified?

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Watch Freddy Lim, StashAway Co-founder and Chief Investment Officer, and Philipp Muedder, Head of Financial Planning, discuss the latest global events and their potential impact on the markets and on our investment portfolios.

In this episode:

  1.  How StashAway protects your portfolio against USD depreciation [1:00]

  2.  Is there such a thing as being too diversified? [6:19]

  3. What Biden’s proposed capital gains tax hike means for your portfolio [9:02]

FULL TRANSCRIPT

Philipp | 00:01

Hello and welcome everyone to another market commentary from StashAway. With me of course, our Chief Investment Officer, Freddy Lim. Freddy, how are you?

Freddy | 00:10 

I'm very well Philipp, it's good to see you. You know, lots of things are happening all the time, but it's good to catch up periodically.

Philipp | 00:18

It's good to catch up. How are you feeling about the new restrictions put in place again? Do you think... Any long-term impact from that? Or is this very much putting the fire extinguisher on a small event?

Freddy | 00:34

It's always been expected that you have this tussle - you know, you win some and then you lose back some ground until the vaccination drive is fully finished. And even with the vaccines, you know, it's not exactly 100%, right? So there will be a tussle. But we need to just get through the vaccination drive before we think about anything else. So this is the tussle right now.

Philipp | 01:00

Yeah, it is a tussle, but we're getting through it. We have to stay positive. Freddy, we've got so many questions today, right? We really want to make sure that we capture them all. So let's get right into it. The first one is from Young Jun Ren, he actually reached out to our customer engagement team and was referring to reading Ray Dalio's book on debt cycles and the changing world order, right? And his question around that is, "Will there be inflation and in addition, the US Dollar devaluation risk to certain asset vehicles to StashAway's portfolio? If yes, to what extent would that happen?"

Freddy | 01:42

Well, firstly, this is a 2-part thing, but let's talk about the debt cycle first. The idea is that governments have basically borrowed too much and have been getting away with repaying it and thankfully interest [00:02:00] rates have been on the drop for many decades. So the cost of financing those steps have been very low. But the key equation is that: as long as the growth rate, the GDP growth rate, is higher than the cost of financing the national debt, then things are OK. And for an open US economy that traces around the world with its reserve currency status, the debt cycle hasn't been a problem. The last cycle we got worried about was in 2010 after all the stimulus that's done. In the 2008 crisis, we got worried about it as well. And then it didn't happen as well. This time, do we get away with it? So it's a deep question. Philipp, sorry, I'm going to take this because it has to do with whether we think governments, especially the US government, is going to maintain its reserve currency status. And I think that cryptocurrency as a cohort is now challenging the sovereignty of paper money in not just the US, but every government. And who knows what will happen in that tussle again. And so, yes, that concern gets brought up every time, but it's a very long-term development. Now, getting back to the question, we have been preparing for this. As you knew, back in mid-May, last year, we re-optimised portfolios to go from all-weather everywhere ex-US to all-weather everywhere including US, and also to re-optimise to avoid the US Dollar depreciation risk. So, it was a very mathematically-driven decision because when you tally the amount of stimulus done by governments - the US by far - has done more than the other side. In the currency, there's always two pairs, right? One country against the other. And say for example, in Singapore, we printed 20% of GDP. But in our [00:04:00] case, when we accounted for how much money was multiplied in the system, we found that the US actually printed nearly two-thirds of its GDP effectively - if we accounted for the secondary effects. And so, of course, the US Dollar would depreciate and it has already depreciated. So whatever we have said and were concerned with, has already happened, right? So, Philipp, we know that the Dollar dropped like 10% to 12% percent on the trade-weighted basis already. So this already happened and our decision back in May last year has avoided those depreciation risks. So that's exactly what we did. And that's why we have a lot of Gold for these unprecedented times of stimulation. And we also have - we invested in tech - we try to avoid US Dollar exposure as well. And so we get into China Innovations as a way to get away from that. So everything happens for a reason and precisely for this reason.

Philipp | 04:58

Yeah, absolutely. Thank you, Young Jun Ren, for the question. Hopefully that was a good answer from Freddy there for you. Freddy, next question was from Mark - and Mark is saying, "Hey StashAway team, seeing a lot of articles and videos about an upcoming market crash. In case the worst thing happened, how would StashAway's algorithm protect us from such catastrophic movements in the markets?"

Freddy | 05:23

I thought we've been around for more than 4 years now and the last 4 years weren't exactly green fields. In 2018, we had 2 market corrections because of Donald Trump's trade war. Last year, we had COVID - which is the second most unprecedented situation for markets and the fastest drop ever, I think, but the second deepest. So we've been baptised by fire as a firm and our algorithm's been baptised by fire for the last 4 years. And if you look at our track record, the short term is always [00:06:00] going to be a bit more moving but if you look at it given enough time, 1/2/3/4 years -  all the consistencies and returns in terms of yearly averages - has been there. So I think the question is asking us, but we have been doing this. That's my answer.

Philipp | 06:19

Yeah, absolutely. Next question is from Wood Liao, he's saying, "According to Warren Buffett, wide diversification is only required when investors do not understand what they're doing." In other words, he's saying, if you diversify too much, you might not lose much, but you won't gain much either. So this is a big conundrum that you hear sometimes come out, right? Because...

Freddy | 06:43

I feel like this thing is actually masking a few complications, this question. First of all, when you are investing broadly across indices that's based on market values. So like, for example, Exxon Mobil last year dropped out of some broad indices and Tesla came in. So the ETF approach of tracking indices, tracking asset classes, will drop Exxon Mobil and will buy Tesla. So it's sort of avoided those problems of being stuck with a name that's no longer in there. So that's already been addressed by that rebalancing mechanism that's pretty much automated in our world, right? So that's the benefit of diversification. However, you can then bring it further and say, I diversify across different asset classes, it's not just the stock markets. Then how much is too much? It's really hard... You have to quantify. If we are just retail investors, then what metrics do you have to know when you are overdoing diversification? So for StashAway, for us, it's easy because every asset class that we add onto our list, we look at whether [00:08:00] it contributes - it contributes by having differentiated return, meaning, we stress test the numbers backward in time and see whether they bring protection to the portfolio when things are not good for example. When things are good, does it have its own independent mind, does it have lower correlations? So these are the stuff that we do in the background when we select funds. That's why some people say, "Why don't you have this? Why don't you have that?", but the reason is because we consider whether it actually adds value to the list or not. By adding value, I mean, is it low correlation? Does it offer protection when the other guys are down? So, this is the meaning of true diversification. I don't think diversification can be counted by just counting the number of assets you have in your portfolio. It can only be countered by looking at the correlation metrics and looking at correlation metrics against many different environments to see how they behave even in greater details and that's what we do at StashAway. 

Philipp | 09:02

Yes and I think you explained it really well in our deep dive seminar, when we look at the different efficient portfolios, the efficient frontier, and how you place them on there, right? By adding these different asset classes. So Wood Liao, if you want to have more insights on this, you can actually go on our app, in the Academy, Freddy actually recorded his deep dive seminar there as well. So if you want to learn a little bit more about that and how StashAway does it, feel free to do that. Next question is from Lee Hiung Chong and he asked, "The Biden administration is proposing to hike capital gains tax rate." Freddy, this was obviously over the last 2 weeks, there was a lot of news around it. But obviously, someone has to pay for the $6 trillion that they're trying to accumulate here for various infrastructure and stimulus cheques. "How would that affect StashAway investments in the US, as well as outside the US? Would [00:10:00] overall sentiment being dragged down over longer periods of time?"

Freddy | 10:04

I think it's a short-term thing. Short-term sentiment is being driven down and has already happened - the market rebounded from there. The market is always forward looking, but the mechanics is more like people worrying if... I mean, when you hike capital gains tax, you actually penalise people for making short term trading decisions in the investment, right? Like, if I made a profit this year and I closed a position, I will have higher capital gains tax on this thing. However, then it forces people to take a longer-term view to their investments. And it's actually a good thing because it makes people think long term. It removes the short bias in the near term. So in a way, I actually see it as being better for long-term investors like ourselves, with this capital gains tax hike.

Philipp | 10:57

Yeah because I think a lot of people are worried that one of the things about capital gains taxes is also, when you hike this they say less money flows into investments and into companies. But I do agree with you, Freddy, that it could actually be a net positive overall because it makes people think twice about selling the investments as well instead of holding it, collecting dividends or whatever that means and getting more gains long term. So thank you, Freddy, for all those answers to all these questions. I want to also give a shout out to Jason Lim. He's saying, "Thank you for the commentary, it's great to hear about the rationale during your Gold allocation," that you had last time, Freddy. "At least now I can understand that it's not negatively correlated to equity." So that's great, thank you, Jason, for that shout out. We really appreciate it. We also have a couple more upcoming webinars. For our Singapore audience, we have on the 20 May, 7pm to 8pm, a joint webinar, Propseller x StashAway. And we're going to talk about Buying versus [00:12:00] Renting A Property. In Malaysia, on 12 May, we have our How to Invest (the Right Way) with ETFs webinar. And for our MENA region, we have again also How to Invest (the Right Way) with ETFs, 11 May, at 12.30pm to 1.30pm, local time. Again, all of those links to sign up for those events are in the show notes below, as well as on our website, social channels, whatever else you can find us. Again, it's a pleasure as always, speaking with everyone and keep the questions coming. Freddy and myself will be happy to answer them again going forward. Until then, have a wonderful week.

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