However, with market volatility around interest rate and credit spread expectations likely to continue amid inflation, weak economic growth and rising political risk, it’s possible investors could see increasing correlation, with both types of asset performing poorly.
Consequently, this traditional approach to positioning is becoming more challenging, and many multi-asset managers are adjusting asset allocations accordingly.
In this article, we’ll explain how we’re managing portfolios given economic and market headwinds. Let’s begin with our fixed income strategies.
Fixed income – support from the yield cushion
We’ve gradually shifted from shorter duration assets into higher carry options - a process that we started in 2020 and have accelerated recently.
Sovereign bonds’ role as a diversifier in portfolios is greater than it was previously.
Clearly the starting yield for global government bonds is more favourable than it was 18 months ago. With this yield cushion, sovereign bonds’ role as a diversifier in portfolios is greater than it was previously.
Meanwhile, we are cautious on corporate bonds. Spreads have not widened to any great extent, and while corporate bonds retain a role in a diversified portfolio, we do not feel that valuations reflect the uncertainty in the broader environment.
Within our credit fund selection, we are also looking for managers who can outperform while deploying a risk budget broadly in line with the benchmark. We believe this offers a robust exposure.
Equities – increasing our US weight
Changes to our equity positioning include a reduction in small cap exposure and an increasing US equity weight. Previously we had quite a high allocation to small cap. This was inconsistent with a more cautious outlook so we have reduced that exposure incrementally, with the aim of reducing our equity volatility.
We increased our US equity exposure in October 2022, and the timing of this change proved to be prescient.
We increased our US equity exposure in October 2022, and the timing of this change proved to be prescient given the subsequent performance. The basis for this decision was a much-improved expected return for US equities following their 2022 performance.
Sustainability - capturing cashflows
We have recently incorporated global infrastructure into its asset class mix. We aim to capture the robust and often inflation-linked nature of the cashflows with the long-term structural growth themes of sustainability and decarbonisation. This is particularly important at a time when growth is scarce.
Initiatives across the world are driving capital into sustainable areas
The Inflation Reduction Act in the US and other initiatives across the world are driving capital into sustainable areas and promoting significant investment into companies that provide green solutions.
Alternatives – the defensive diversifiers
Despite the improved diversification properties for government bonds at current yield levels, we continue to believe that defensive diversifiers play an important role in portfolios given the volatile outlook we’re expecting.
The objective is to provide defensive exposure in challenging markets without simply being a portfolio hedge. Our 2022 fund recommendations achieved positive absolute returns - which was important in the context of their role in portfolios. We look for managers who provide an exposure that we cannot access through our strategic asset allocation investment framework but who are not overly reliant on making big directional market positions, given how difficult this method is of consistently producing positive absolute returns.
Navigating challenges and opportunities
Thanks to rising interest rates in developed markets, the yield available on fixed income assets has been significant – justifying an alteration in the structure of portfolios.
While bond allocations have been subject to the greatest change for multi-asset managers who are looking to take advantage of higher yields and improved diversification characteristics, the role of diversifiers such as alternatives remains important.
Portfolio managers are adapting their strategies to navigate the challenges and opportunities in the current market environment. By staying diversified, agile and focused on areas with long-term growth potential, multi-asset managers can target positive outcomes for investors.