What now for cautious investors?

But the events since the global financial crisis have called those easy assumptions into question. And 2022 year-to-date has further contributed to the uncertainty, with those assets delivering highly volatile outcomes.  

James Beaumont, multi-asset investor at Natixis, says the challenge for investors this year is that “the risk assets and the low-risk assets are correlated, which obviously is not supposed to happen. But it won’t last forever”. 

Many market participants are used to thinking in terms of economic cycles, according to Kevin Thozet, multi-asset investor at Carmignac, but “since 2010 it has not been a normal cycle, it has been acyclical.

Government bonds are a tactical and not a strategic investment in a cautious portfolio.David Coombs, Rathbones

"What we are experiencing now is the start of a more normal cycle, and so over the longer-term our view of markets is not that different relative to history because this is closer to normal."

Guillaume Paillat, who runs a cautious multi-asset portfolio at Aviva Investors, says: “Clients in this portfolio have been on the phone to us, asking us what is going on. They are very concerned because this year has not been what they signed up for.”

He says the central bank policies of quantitative easing “front loaded the returns from government bonds. We got years worth of returns in a short space of time. What has happened this year is, we have effectively given back those years of front loaded returns in a very short period of time”. 

Diversification

David Coombs, head of multi-asset at Rathbones Unit Trust Management, says: "Government bonds are a tactical and not a strategic investment in a cautious portfolio. There is a right time to own them, which is when bonds are not correlated to equities, and a time not to own them, which is when they are correlated.

"Given where yields are now, we are buying government bonds. But until recently we were not."

There is nothing wrong with having some cash at hand to take advantage of opportunities that might arise.David Coombs, Rathbones

His approach right now is to “have diversifiers more than ever. But it’s important to have actual diversifiers – some people own [real estate investment trusts] as diversifiers, but really they are correlated with the wider economy and with equities.

"Right now, cash is a diversifier. Of course it has produced a negative real return this year, but so have many other assets, and there is nothing wrong with having some cash at hand to take advantage of opportunities that might arise.

"The other areas we like right now are absolute return funds and macro strategies, as we live in a world where a lot is happening on the macro front.

"But also, actually you could have an overweight exposure to energy right now, in a cautious fund, that is a hiding place.”

Changing assumptions

Keith Balmer, multi-asset investor on the Universal range at Columbia Threadneedle Investors, says the error that many may make now is to change long-term assumptions about asset classes based on the events of this year.

He says that while much has happened in markets, “they should be seen as a series of shocks, mostly supply-side shocks that will pass. A cautious portfolio is designed to provide some return but also to have capital protection.

This year has been a period where everything that has done well is doing badly.Keith Balmer, Columbia Threadneedle Investors

"Government bonds have historically helped with that, and when the shocks we are seeing now dissipate, they can go back to playing that role in portfolios. 

"There is also a role for cash in a cautious portfolio, but I think you have to be careful about having too much of it, because there isn’t much point in being invested if you just own lots of cash."

Balmer adds: "But what has changed is that over the past decade, if you had some US equities and be long duration on bonds, that was enough to get a decent return without taking much risk or experiencing much volatility. The factors that made that strategy compelling have changed.

"This year has been a period where everything that has done well is doing badly.”

Alternative strategies 

He is sceptical of the use of alternatives such as hedge fund strategies as, while they may be uncorrelated with wider markets, “they tend to be expensive and performance has not been there. I would say as well, that many of those strategies invest using leverage and I am not sure that is appropriate in a cautious portfolio.”  

Beaumont confesses to having his “highest cash position ever” in portfolios right now, and is underweight both government and corporate bonds, as well as equities. 

Unlike Balmer, he is now looking at absolute return and macro hedge fund type strategies. He acknowledges the performance of these products has been weak in recent years, but says that was a function of buoyant markets.

"It was hard to justify investing in a long/short equity fund, for example, when markets are going up. In that environment, the traditional 60/40 portfolio worked very well, and it was hard to justify holding a long/short product. But now the conditions are different."   

I am not prepared to give them my clients money to do the job I am paid to do.Fahad Hassan, Albemarle Street Partners

Fahad Hassan, chief investment officer at Albemarle Street Partners, says: “The issue I have with products such as absolute return funds is that they are basically designed to do what we do, build multi-asset portfolios delivering returns, but are more expensive.

"So I am not prepared to give them my clients money to do the job I am paid to do. I think that over the next 12-18 months inflation will normalise, and actually now is not a bad entry point for investing in bonds.”

A key consideration, says Shaniel Ramjee, senior investment manager at Pictet Asset Management, is whether inflation remains higher over the longer term or falls back towards the 2 per cent central bank target as the impact of the events referenced by Balmer dissipates. 

He says if inflation does remain higher, this will likely mean increased levels of volatility, and place a greater focus on asset allocation.

He feels that “passively” allocating to certain asset classes would, in those circumstances, leave clients exposed to that much higher volatility, which would not be appropriate for a client with a cautious risk profile.

Ramjee says asset allocation needs to be more nimble and tactical in those circumstances. 

david.thorpe@ft.com