1. Know where you stand. The question here is whether a portfolio is currently positioned so that it will do better if the rule works again or if the rule is, in fact, broken. For example, a portfolio benchmarked to a market-cap-weighted global index is already tilted toward the idea that the “diversification adds value” rule is broken. Consider the weight of the US in the MSCI World Index: Over the past half century, it averaged 52%. Today, it’s above 70%, so the index and portfolios benchmarked to it are significantly less diversified. Or to offer another example, a portfolio that is currently “style balanced” between growth and value is effectively neutral relative to the rule that winning investments of the last decade rarely outperform in the next one.
2. Where you have confidence, tilt toward the rule. My bias is to bet against the idea that “this time is different” and to tilt toward the rules where asset owners have confidence. My confidence in the value of global diversification over time is relatively high, for example. Thinking back to the late 1980s, Japan had become a disproportionately large weight in the global market, not unlike the US today. At the time, it wasn’t difficult to make a case for a large allocation to Japanese equities, but it turned out that investors were well served by having a diversified portfolio in the decades that followed.
Asset owners looking to diversify globally today could consider adding broad non-US equity allocations (here I see a case for pursuing both beta and alpha), targeted emerging market allocations, or exposure to individual countries that may be attractive, such as Japan and India.
When it comes to growth and value stocks, I still have medium to high confidence in the rule that investments don’t generally repeat their success over consecutive decades, despite the recent exception to the rule shown in Figure 5. For asset owners who agree and want to lean into value after a long stretch of growth outperformance, I would consider value strategies that are index-agnostic or are benchmarked to a core index (avoiding the baggage of sector concentration that can come with a value index). I also think value may have a bit more runway in markets outside the US, which don’t have the same uphill battle against the mega-cap tech sector. Finally, quality value allocations may be worth a look — even if the value/growth cycle continues to tilt away from value, quality exposure could be another potential portfolio driver. (On a related note, my colleagues recently took on some of the rules of thumb often applied to value stocks in particular.)
3. Consider the risk of being wrong. Asset owners should manage positions to account for the possibility that “this time is different” for some rules. Let me give two examples. First, on the private equity side, I expect, as noted, that distributions will eventually get back to levels that can fund capital calls. But to account for short-term periods where this isn’t the case, asset owners may want to do more modeling and stress testing of capital calls and returns to help ensure a robust private equity program. They might also consider adding shorter-lived private equity exposures to the mix, such as investments in secondaries or late-stage venture capital. I would also prioritize vintage-year diversification. While there may be a distribution/capital call mismatch now, the risk of not making private equity allocations and missing a year could be significant.
Second, asset owners who lean into the rule that “winning investments from one decade rarely outperform in the next one” should bear in mind they may be adding exposure to structurally challenged allocations or at least fighting strong short- and medium-term momentum. This could be the case not just in value, but in areas like non-US and small-cap equities. In a sense, leaning heavily into all of those areas could amount to one big bet against the continued run-up in US mega-cap stocks. I am not arguing against making those tilts, but investors should size their total exposures to ensure they don’t suffer disproportionately if the current market climate prevails for longer than they expect.
4. Prioritize education and governance. Assessing whether these rules of thumb are broken will require a degree of patience, so this may be a moment to focus on education with a board or governance team — to re-underwrite the organization’s confidence in each rule and comfort level with the possibility of being wrong.