In Focus: Megatrends  

Don't build investment case on geopolitics, advisers warned

"When we think about a sharp slowdown in the economy it seems to me that that's not been priced in to most asset classes.

"We see very high valuations in most assets across the world and that's typically not consistent with widespread expectation of a significant slowdown."

The reason the potential event has not been priced in is because things have been moving so fast since the pandemic investors may have not caught up yet, he said.

Central banks have been somewhat cautious in their tightening too, so there is uncertainty over when the current pulse will come to an end.

Adding value

In his report Kemp said when diversifying for a negative equity environment investors must understand the underlying risks to assets.

The report stated: "To us, it is about understanding the underlying risks to assets, whether that be economic or market-risk factors - not just volatility or correlations (as these can change quickly and drastically). 

"For example, corporate bonds and equity markets can behave very differently, yet both are susceptible to an economic shock (damage to corporate earnings could cause equity values to fall and bond spreads to widen).

"All else being equal, this offers less diversification than holding equities with an unrelated asset, such as inflation-linked bonds or nominal government bonds. The message is to diversify against fundamental risks and be very intentional with how you are diversifying if you want to reduce the impact of an economic recession."

To really add value, Morningstar said, advisers and investors should take a long-term view and consider whether they can benefit by buying into negative sentiment.

Investors should not engage in widespread selling based on fears of an economic recession but only really care about a permanent impairment to earnings and the price paid for those assets, Morningstar said.

"If the economic cycle dents corporate profits in the near term, we may have the opportunity to buy into the negative sentiment and ride it out until the cycle reverts. This is one of many areas where we can add value, by maintaining a long-term view when others won't."

carmen.reichman@ft.com