Investing across a diverse range of asset classes can be a simple way for investors to improve potential returns, while lowering portfolio risk at the same time.
In recent years, economic conditions have proved highly favourable for investors, with most traditional asset classes delivering strong positive returns. Equities in particular have performed well, while bonds have also made significant gains. Since the end of 1987, global equities have delivered an average inflation-adjusted return of around 5 percent per annum. However, as we all know, this level of return comes at a price: namely, volatility. Sharp corrections and bear markets can wipe out years of positive returns in a relatively short time.
Central banks have played a big part in driving up bond and equity markets over the past decade, providing cheap and plentiful cash to stimulate economic activity – but the party cannot last forever. At some point in time, the extraordinary monetary policy support applied by most central banks, in combination with an increase in tariffs on globally traded goods, could very well lead to reflation, and hence ultimately to higher interest rates. This will present a headwind for traditional portfolios that rely only on equities and bonds for returns.
Financial markets are subject to, often exaggerated, human responses to events.
The opportunities for achieving above market returns and controlling risk do not stop with equities and bonds. By making alternative investments, e.g. private equity or private infrastructure, another key component of our multi asset funds, we aim to enhance potential returns and reduce overall portfolio volatility. Holding alternative assets that have a low correlation with movements in bond or equity markets is a key factor in efficient multi asset strategies, and therefore well suited for the current challenging investment environment.
Private infrastructure, for example, gives investors exposure to interesting projects in hospitals, schools, transport networks, or utilities – all major investment areas once confined to the public sector. Squeezed government budgets following the financial crisis have brought many of these opportunities to the private sector. Large infrastructure projects can generate long-term income with often surprisingly low risk, because they are in many cases backed by governments via publicprivate partnerships. Infrastructure investments are relatively defensive, lowly correlated with core markets, and often provide inflation-protected returns.
Moreover, financial markets are subject to, often exaggerated, human responses to events, as well as the behavior of other investors. Just like people, markets can thus shift very quickly from relative calm to chaos, and at times behave irrationally. Investing part of the portfolio in private markets such as private infrastructure or private equity can reduce the overall sensitivity of the portfolio to big swings of market participants’ mass sentiment.
At the same time, the behavioral biases that dictate investors’ short-term decision-making can on the other hand often give rise to attractive investment opportunities. Portfolios with a flexible investment approach can thus offer strong downside protection, given their lower sensitivity to public markets, and free up risk budget that investors can use to take advantage of market dislocations.
Returns from global equities and bonds are likely to be harder to come by in the future, and investors will need to cast the net wider to achieve their performance goals. A diversified multi asset approach is particularly well suited for the current environment, expanding the opportunity set for returns, while providing greater resilience in periods of market stress.