InvestmentsMar 18 2021

Constructing a multi-asset portfolio for the risks of the future

Supported by
BMO Global Asset Management
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Supported by
BMO Global Asset Management
Constructing a multi-asset portfolio for the risks of the future
Dmitri Demidov/Pexels

Matthew Yeats, head of alternative and quantitative strategies at 7IM says the crux of the issue for asset allocators is the role of bonds in portfolios.

Traditionally asset allocators view government bonds as a way to diversify away from the risks associated with equities, but he says that over the past decade the persistent fall in bond yields, and consequent rise in the value of bonds means he feels bonds no longer have the same place in a balanced portfolio.

We think with fiscal and monetary policy markets are looking reasonably supported but there are certainly some areas of excess – in US tech for example Paul Niven, BMO GAM

Yeats says many balanced portfolios were constructed on the basis of a 40 per cent allocation to bonds, but he believes that in the current market environment, a much smaller allocation to bonds is appropriate. His fixed income allocation has dropped to about 25 per cent, and alternative assets comprises the 15 per cent he has removed from bonds. 

Lane Prevenost, global head of discretionary asset management at HSBC Asset Management, says that with bond yields so low, it is valid for investors to be concerned that they may not offer much protection in future, particularly if the risk a client is seeking to guard against is higher inflation.

Diversity

Ursula Marchioni, head of BlackRock portfolio analysis and solutions for EMEA says it may be that clients are best off retaining their existing level of exposure to bonds, but creating a more diverse range of fixed income assets to make up the allocation than may have been the case in the past.

Sunil Krishnan, head of multi-asset investing at Aviva Investors, says the main outcome of the exceptional policies pursued by governments and central banks is that asset allocators now do not need to worry too extensively about forecasting the outlook for the economy. 

He said instead of forecasting, he believes asset allocators  need to focus more on the impact of possible changes to policies from central banks, which could be the catalyst for a change.

This is the opposite of what might have happened in the past, when market participants might have concentrated on forecasting the economic outlook, and treated the policy responses as a by-product of those. 

He says the strength of policy responses in 2020 was such that the pandemic-induced recession “could start to just look like a blip in the chart”.

Good news is bad news

Krishnan says an outcome of the market trying to second guess the policymakers, rather than forecast the economy, has been the recent phenomenon of good economic news being treated by the market as bad news for the wider economy.

As economic and vaccine data proved positive, markets began to sharply sell off most equities and bonds, on the basis that such good news would lead to policy changes from central banks and governments, and those changes, particularly to interest rates, would have a profoundly negative impact on asset prices.

Krishnan believes that, even as economies open up and inflation starts to take hold, policymakers will hold off from increasing rates, and once this is communicated to markets, good news will once again be good news. 

If the economy does not progress as expected, then rates and other supportive policies would continue anyway. In this way, understanding the central bank’s intentions is more relevant than understanding the economy in the current climate.

Krishnan says that if central banks keep rates low, then both bonds and equities can continue to rise. 

He describes that situation as a “new normal looking a lot like the old normal”. In this case, the old normal are the conditions which prevailed in the decade following the global financial crisis, with anemic growth supported by low interest rates, being enough to push both equities and bonds higher.

He says the variable over the next decade could be that governments increase spending, while the previous decade was pockmarked by spending cuts, but he says “the burden of proof” is with those who believe a change is coming.

Equity valuations

Paul Niven, who runs the MAP multi-asset fund range at BMO GAM, says: "Many commentators are concerned about valuations in equities. 

"We think with fiscal and monetary policy markets are looking reasonably supported but there are certainly some areas of excess – in US tech for example. 

"Avoiding such pockets and emphasising sectors and companies where valuations are less stretched is a sensible way of adding an element of downside protection."

If we are on the cusp of a profound change in markets, Nick Watson, multi-asset investor at Janus Henderson, says persistently higher US government bond yields would be the signal.

In such a climate he believes European and Japanese equities, alongside alternative assets such as renewable energy, would thrive. 

Steven Hay, multi-asset investor at Baillie Gifford believes inflation will rise, which is different to the past decade, and that real assets such as gold will perform well in such a scenario. 

He says: “We have had 40 years of inflation being low and bonds doing well, but I think that is about to change, and requires new thinking.” 

Catherine Doyle, investment specialist in the Real Return team at BNY Mellon, says she does not expect inflation to rise sharply, but does expect it to be consistently higher than has been the case over the past decade. However, companies in areas such as electric cars will continue to grow, regardless of wider economic conditions.

Lane Prevenost, global head of discretionary asset management at HSBC Asset Management, says that with bond yields so low, it is valid for investors to be concerned that they may not offer much protection in future, particularly if the risk a client is seeking to guard against is higher inflation.

David Thorpe is special projects editor of FTAdviser