David Marshall: Hello, I'm David Marshall. I'm here with Robert Spencer from the Investment Solutions Group. Today we're talking about the MRI. It's also called the Market Regime Indicator. Rob, can you tell us more about what the MRI is all about?
Robert Spencer: Sure, David. The MRI is our global multi-asset class barometer of risk. It tells us whether investors are willing, or seeking, risk or if they're more fearful— [it] helps us to answer that question. And we use that to help us take active positions in our multi-asset class portfolios. When investors are calm and willing to take on risk, we tend to see that as a signal where we should overweight risk assets like equities.
On the other hand, when investors are more fearful, they're exhibiting higher levels of risk aversion. We want to be more cautious in the portfolio and reduce exposure to risk assets like equities in favor of other segments that are more of a tail risk hedge like cash, long duration government bonds, and gold.
Now the signal comes to us and allows us to classify this investor appetite into one of five regimes: in the middle we call that normal; below, if investors are more calm, we call that low risk; then we have euphoria where investors are very, very calm. On the other side, we have high risk and crisis. We've been using this tool since 2011 in our active asset allocation process.
David Marshall: Rob, I think it's a great time to talk about the history of the MRI. So when we go back to, let's just say all the way to 2000, we get a picture of the distribution of the different regimes that the MRI has been in.
And for the most part, it follows a normal distribution whereby most of the observations are in the center. But at the extremes you see fewer observations. At the extremes, we once again have euphoria and crisis. But to give you a greater understanding of the MRI so it does not seem like a black box., let me just talk about a couple of periods that we experienced historically. In 2018, we were in this euphoric regime, for example, whereby investors were extremely complacent. Right after that, however, interest rates went up and obviously investors had to change their expectations.
We could also move to another period called crisis. We can go to February of 2020. This was a COVID crisis. This is when people got extremely uncertain about the marketplace. They moved more money to cash. They also moved money to T-bills because of the great uncertainty that was out there. But fast forward once again to another period of euphoria, February 2021. Once again, the markets were feeling good about themselves and they actually took the market up 28%. But I guess what I really want to know, Rob, is how are we using the MRI today?
Robert Spencer: So we're using the MRI directly in our asset allocation or active asset allocation process. Again, it helps us to know what investors are thinking —are they willing to take on risk or are they more fearful? And we want to use that as a signal to overweight or underweight risk assets like equities in a portfolio, for example.
Now, it is a global, multi-asset class barometer. So global means that it's considering markets in the US as well as those outside of the US and its multi-asset class because we're looking at both equities, we're looking at currency and we're looking at credit — high yield and risky debt —to get a sense of how investors are thinking about risk. Now, currently we're in a low risk regime environment, which is sort of on that tail of the distribution where investors are very calm, they're willing to take on risk. And this is typically a time where we would overweight risk assets like equities. If you look under the hood though, the story is a little bit more nuanced.
While both equity and currency volatility, implied volatilities, which are the key metrics that we're looking at, are very benign, spreads on risky debt are a little bit more elevated in the normal regime. So there is that little bit of a disconnect. If you add to that the external risks that we're seeing, whether it's a slowing economy, sticky inflation or the debt ceiling showdown. If you take those two things into consideration with that backdrop, while we are overweight equities, we're a little bit more cautiously positioned than we otherwise typically would be.
Treasury Bill (T-Bill)
A short-term US government debt obligation backed by the Treasury Department with a maturity of one year or less.
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