Outlook 2021: Multi-Asset

In reflecting on 2020 I keep coming back to the great philosopher (and boxer) Mike Tyson who is famously quoted as saying “everyone has a plan ‘till they get punched in the mouth’”. To some extent that’s a bit like how 2020 felt like as an investor. It’s also a reminder of the perils of forecasting the future but also the need to be adaptable simply because things rarely go exactly to plan. This would also suggest that you should probably take what you’re about to read with a proverbial “grain of salt."

That said, we need to at least plan for 2021 on the off chance it unfolds in a much more predictable way.

The key to me in thinking about what 2021 may hold is to focus on what we know today.

Firstly, we know that central banks have cut official rates to negligible (or negative) levels and this has both directly and indirectly dragged down yields across the interest rate and credit curves. For debt investors in 2020 this has been good as they’ve accrued capital gains as bond prices adjust higher to reflect lower market yields. For many investors it’s only when you go to roll a term deposit with the bank that the reality of where yields are and what this means for future returns really bites. We can say therefore with a high degree of confidence that returns from cash and fixed income investments, particularly at the lower risk end of the spectrum will in absolute terms be lousy in 2021.

To put some scale on the challenge investors will have over the year ahead generating satisfactory returns from their fixed income investments, a recent Bank of America study showed that 70% of global fixed income securities were yielding less than 1% and around 90% less than 2%. This means that if we take away inflation, only around 10% of the investible fixed income universe is generating positive real returns.

Figure 1: 70% of global fixed income yielding <1%


Source: Bank of America Global Research

Secondly, equities have approached year end on a positive tone (the S&P 500 at record highs), driven by positive momentum in key economies (and profits), encouraging developments around vaccines and perhaps most importantly liquidity conditions, in particularly the very low levels of bond yields and interest rates more broadly and explicit and implicit central bank support for asset prices. This is reflected in valuations, which while not extreme, do require both economies and profits to deliver in 2021 to be validated. Market positioning surveys and other measures of investor optimism are pushing extremes which held up against full(ish) valuations do warn against complacency.

The bullish arguments for equities from here reflect 2 key perspectives. The first, that recovery is coming and that the low levels of interest rates and high levels of liquidity in the system will support further gains. The second is that low yields and negligible returns on cash, will simply force investors to hold equities irrespective of the risks.

Our framework suggests caution but not outright bearishness with respect to equities and in fact for broader risk asset positioning. We do expect economic recovery to continue in 2021 but it will be challenged at times. We also expect that liquidity conditions will remain extremely positive. We are preparing for a rocky road ahead but a road in which risk assets will likely remain well supported.

Against this background there are a number of key observations we would make:

  • Starting points matter and this means low returns from cash and fixed income assets in 2021 are virtually assured. There are opportunities to improve income and returns more generally but a broad investment universe will be required to identify and implement;
  • This also means investors need to be more careful about where they take risk as low sovereign bond yields make it more challenging to hedge risk (particularly) equity exposures elsewhere in the portfolio. Our approach is to utilise the full capital structure and in particular make use of higher risk defensives which offer better returns than cash and low yielding sovereign bonds without assuming all the risk of equities. We also expect defensive currencies and options to mitigate downside risks will be important;
  • Volatility will again feature in 2021. In some ways this is good news as it means there will be opportunities for active asset allocation approaches to add exposures as risk premium in key assets adjust;
  • Finally, investors need to keep a close eye on inflation. While in the near term excess capacity in key product markets and importantly the labour market created through the Covid-19 recession will keep a lid on inflation as the recovery takes hold in 2021, the extent to which policy settings are aimed at generating inflation could raise the risk of inflation rising above recent norms in the medium term. This could lead to pressure on bond yields and policy support mechanisms over the medium term which could threaten the cocktail of support that markets have grown to love and rely on. This would be a catalyst for more structural difficulty for markets.

To summarise, markets are entering 2021 in a confident position. Confident investors are not always rewarded. Our own position can be summarised as recognising the positives of liquidity and economic recovery against the fact that much of this is already discounted. Caution but not outright bearishness is our plan, but, we are fully prepared to be “punched in the mouth” again.

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