By David Vickers
Multi-asset portfolio management is like cooking: you need good ingredients, but it is the delicate combination of them that makes a good dish great. Dishes need flavour – risk – but in the right and complementary quantity.
Like any investment decision, choosing how to create and balance a portfolio for economic recovery is a matter of trade-offs. Individual strategies can look pretty sound on a stand-alone basis, but if all these views are in a portfolio at the same time, as an investor you need to ask yourself: are you happy with the overall level of risk?
There are many risks and uncertainties, as well as opportunities, and therefore investors should not be complacent. Many investors are positioning for recovery, and for those on this side of the fence, there are several investment strategies they may want to consider:
1: Short duration in a rising rate environment
Fixed income that is less sensitive to rising interest rates, such as short-dated credit, loans, and high yield, will hold its value better. However, this comes with higher credit risk and the resultant portfolio will typically be lower credit quality than all-duration investment grade credit.
2: Overweight risk assets generally
Risk assets are favourable for those investors predicting the global economy will grow, but don’t forget, risk assets are, well, risky.
3: Overweight real assets
Rising inflation, driven by healthy demand, feeds directly through to higher prices and yields in real assets. Property, infrastructure and commodities have the potential to do well in this scenario. However, many real assets have been bought for their relatively higher yield compared to bonds in recent years, and as this gap narrows or even goes into reverse, investors may want to consider switching back to bonds in the search for yield.
4: Growth bias in equities
For those looking to capitalise on rising equity earnings, driven by economic recovery, growth stocks, small cap and emerging markets are the likely beneficiaries. Equity valuations have already priced in a lot of growth, raising the bar for where earnings have to come in in order not to be a disappointment. That said, we still think Europe is cheaper on a relative basis and that it is too early to take profits from Europe. Valuations appear expensive looking at standard metrics, such as trailing price earnings, but this is misleading given that last year was the first year of earnings growth in four years. In contrast, the US is a more mixed story. On the one hand it is a growth story, but the recent slowdown in the data and the potential for further oil price declines tempers this.
When constructing a portfolio made up of a range of different asset classes an investor needs to look at what will happen to each part of their portfolio if the economic recovery gathers pace. From here they can then decide where the best opportunity to profit from recovery exists. Taking the views above, for example, if an investor ups the juice of their credit portfolio with lots of shorter-duration, but punchier credit, they should consider toning down the growth or small cap bias in the equity segment. If they were thinking about increasing their allocation to real assets, they could balance that with other high-yielding assets that might benefit from outflows from real assets. Finally, if an investor is overweighting risks assets generally, perhaps they should include some skill-based strategies that are less sensitive to the economic cycle, such as volatility-based strategies.
It is a far bigger challenge than in the past to generate investment returns. We are not going to make any money by parking our assets in cash. Furthermore, fixed income investors are likely to be disappointed, as the next 10 years are very unlikely to provide returns anywhere close to what we have been accustomed to since the 1980s. Investing across a range of asset classes and regions is more likely to generate an attractive return on a risk-adjusted basis, but looking at each of them in isolation could result in a disappointing dish.
David Vickers is senior portfolio manager of the Russell Investments Multi-Asset Growth strategy
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