A core feature of the past decade has been the prevalence of unexpected events driving most, if not all, assets down. These events were also mostly "unknown unknowns" which disrupted even the most comprehensive scenarios we as investors can plan for.
Our investment philosophy always brings us back to simple principles and is rooted in humble convictions: what if we are broadly unable to forecast what’s next?
So, the real challenge, in our view, is not to cherry-pick datapoints that support a preferred scenario, but to make sure we have the tools in place to cope with any scenario.
Higher-for-longer interest rates in the next decade is a risk.
While market participants continue to focus on the short-term debate, we are considering the possibility of a longer-term regime change that may be already well underway.
Stimulus packages from the pandemic, savings built up during the same period and funding packages associated with the transition away from fossil fuels and other climate harms mean that elevated real rates could be here to stay.
Today, deeper deficits, incurred by stimulus, are still supporting prices and may exert a long-term inflationary effect.
Friction and structural change in supply chains following the pandemic – as deglobalisation and protectionism feature more prominently in industrial policy – are also driving up input costs for businesses, further underpinning more structural price increases.
But with economies slowing and demographic trends underway, consumers are progressively drawing more on accrued savings.
Beyond the consumer, the environmental transition requires immense investment by governments and businesses of approximately US$5.5trn (£4.4trn) annually to 2030.
This stands to further increase deficits and drain savings, especially as strong demand will increase the cost of materials and skills needed to green the economy.
As consumers spend today and investments are committed to the economy of tomorrow, the structural support for higher real rates gets stronger.
What does that mean for traditional multi-asset portfolios?
Changing macroeconomic and financial conditions
We may wonder if 2022 was just a bump in the road or rather a structural turning point.
After decades of low economic inflation (if not disinflation), 2022 reversed to an inflation shock.
With this reversal episode, multi-asset investors face an inevitable question after a forgettable year for equities and fixed income: is it time to abandon the 60/40 portfolio?
We are not necessarily calling the end of the 60/40 as an obvious scenario, but we strongly believe the model carries weaknesses and investors should seek improvements.
The 60/40 portfolio is built using long-term data and assumptions.
Last year has showed that risk profiling (or control) based on long-term correlations between asset classes can put investors in uncomfortable situations when these relationships break down.
Covariance structures – the patterns describing how bond and equity returns behave jointly – can be volatile enough to challenge the most well-conceived diversification strategy.
Change is constant and risk is restless: we should beware of using long-term data as a guide for the future.
For an investor questioning whether to dismiss the 60/40, we believe these insights call for prudence.