Some commentators believe traditionally low-correlated asset classes are starting to move in the same direction. Pádraig Floyd investigates what this means for multi-asset funds.
In recent years, investors have chosen multi- asset products as a means of protecting themselves from volatility and to guard against the downside.
But commentators have warned correlations between asset classes have begun to converge again and that investors must take care to protect against a market shock. So where does that leave multi-asset investing?
THE CHALLENGE
The big challenge of multi-asset investment is that equity markets are all well correlated, says Toby Nangle, head of multi-asset allocation, Columbia Threadneedle.
“If you believe in the risk/return notion of combining assets such as government bonds with equities, real estate and a spread of corporate bonds, then if they become correlated with the discount rates of other asset classes, this is a problem.”
Correlation changes over time, but this problem is due to the historically low markets. Despite people being less concerned about correlation, earnings yields on equities compared to investment grade and high yield over the last few years has seen a tightening of the spread which means that all in yields have been falling on bonds and so equity yields have been falling.
Forward price-to-earnings ratios (P/Es) have risen by 40% over the last three years says Nangle, the same rise experienced in global equities prices. Earnings have fallen while forward P/Es have been rising – this is a valuation effect, a function of falling discount rates, not fundamental growth.
NOT GETTING ANY EASIER
Things have become more difficult and we were already at the end of a 30-year rally on fixed income yields, yields which have kept going lower.
While this is more apparent in some markets than others, the trend is the same across the developed world, says Marino Valensise, head of multi-asset, Barings Asset Management.
