Peter Fitzgerald of Aviva Investors on how to protect portfolios from the anomalies policymaker activity has created - and prepare for the challenges yet to come.
The global economic outlook remains uncertain, with growth anaemic and unemployment elevated in the developed world. These strains are being exacerbated by the fiscal constraints being imposed on governments by high debt levels.
Despite these uncertainties, many developed equity markets have been at, or approaching, all-time highs. You can, therefore, excuse multi-asset investors for being puzzled.
Focusing on long-term fundamentals has to be the starting point for any multi-asset investor. With yields at all-time lows on the majority of fixed income asset classes, tilting the portfolio towards risk assets, and in particular equities, would seem sensible if one takes a long-term view. This approach should provide the anchor in the construction of any multi-asset portfolio.
How to turn uncertainty to your advantage
Adapting this long-term portfolio to take account of short-term risks or difficulties is a complex challenge. In 2012, for example, policymakers had a significant impact on global markets.
Policy action included the monetary injection from the Federal Reserve via QE3, Draghi’s plan to do “whatever it takes” to stabilise Europe’s troubled sovereign debt markets through the outright monetary transaction (OMT) programme and the Bank of Japan’s expansion of its balance sheet and increase in its inflation target.
Central banks have retained their proactive approach to liquidity this year and are providing a platform for equities to continue to perform strongly. Being over or underweight equities will, of course, determine much of the success of a multi-asset portfolio. However, for portfolios to remain robust over the investment cycle, investors should position them to account for the anomalies that policymaker activity has inevitably created.
Firstly, with central banks pinning down interest rates, yields have been driven to low levels across the majority of fixed income asset classes. The viability of defensive and cautious multi-asset funds having significant allocations to gilts is in question. More so than ever before, it is important to be active across the fixed income spectrum.
With this in mind, investors should look to diversify their fixed income holdings globally, avoiding the concentration risk of investing solely in the UK. Investing in floating rate securities that can provide a yield without the interest rate risk appears sensible.
However, it is important investors understand the liquidity of these instruments. Asset classes such as loans and asset-backed securities look attractive but they tend to lack the liquidity of more traditional fixed income asset classes and, therefore, prudence would dictate small allocations.
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