5 defensive allocation ideas for 2022

1. More challenges ahead for bond markets

Thought 2021 was a tough year for bonds? Things are likely to get tougher from here, and there are two key risks for investors to consider.

Firstly, COVID-19 is still around. Vaccine rollouts have happened and economies are opening up, but there are still risks around new strains developing and immunisation efficacy waning. This has been made particularly evident by the emergence of the omicron variant in late November 2021.

The second risk is inflation – something that is starting to concern bond markets. It’s a truism that inflation follows high growth. The V-shaped recovery has created strong demand which has shifted from tourism and hospitality to home spending on renovations and electronics.

This has moved people’s focus to the supply-side driving inflation, fuelled by labour and production shortages and bottlenecks in supply chains. Some of these factors may persist a little longer, but it’s unclear if there has been a genuine change to the inflation dynamic. However, the policy of central banks still remains very expansionary, which suggests there are some upside risks.

2. The corporate landscape is changing

The response to higher inflation has seen the corporate sector passing through increased costs to the consumer, keeping revenues strong and margins high. But there’s every chance that could change.

Funding costs may start to go up and wage price pressures may start to come through, placing pressures on businesses which may then fail. This happens in every cycle, so it’s important to avoid those companies that have heightened default risk through bottom-up credit research and analysis.

As we move through this transitory phase, it’s likely there will be upward movement in the very low business default rate that we’ve experienced recently – which will bring both challenges and opportunities for corporate bond investors.

3. Active management and diversification are vital

Active management provides the ability to reduce duration in the current environment and, in the case of the Schroder Absolute Return Income Fund (SARI), the ability to use other diversifiers such as currency.

However, not everything in the fixed income universe is expensive – there are opportunities offering value which makes this an ideal time for active management.

One area of interest is the Asian credit market, which is much more broad than just the Chinese property market (which usually attracts the headlines).

Fixed income markets, in turn, are larger than equity markets – and being an active manager will be key to optimise opportunities.

4. Sustainability and ESG are now central

Sustainability and ESG factors are integrated into Schroders’ investment process, in order to capture how they affect return and risk opportunities. This integration has been comprehensive and holistic from the top-down, via asset allocation, as well as from the bottom-up, via the fundamentals.

The investment team has undertaken modelling around climate change to estimate its impact on long-term economic growth and inflation. This data is then fed back into forecasts for returns across different asset classes.

We also use data available in the public space on the very wide universe of global companies across a range of different ESG factors. As part of this holistic approach, we blend the top-down quantitative inputs with the fundamental qualitative assessments.

5. Cash is not necessarily king

Cash plays an important role in portfolios, but for investors holding higher levels, rising inflation means a negative real rate of return on their funds. While cash may give you liquidity and capital stability, it’s important to deploy it wisely over the longer term.

The appropriate cash levels will depend on what an investor’s trying to achieve with their portfolio and the state of the markets.

Cash should be part of a broader investment strategy and you need to know what role it will play. It can be deployed very quickly to take advantage of opportunities as they arise, but holding cash needs to be part of an active strategy.

Learn more about the Shroder Absolute Return Income Fund or Schroder Fixed Income Fund

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