The end of the current growth cycle is looming on the horizon, but choppy market conditions are no reason to be pessimistic, according to Schroders’ Simon Doyle who urges investors to get active because there’s no such thing as a free lunch.
With a slowing global economy and ongoing turbulence in the markets, multi-asset strategies could provide investors with solutions to their investment objectives. But with so many approaches available, they need to be aware of the risks and appropriateness of each strategy.
Schroders’ Simon Doyle, head of fixed income and multi-asset, Australia, said asset managers need to be active and to avoid common mistakes during difficult trading periods.
“The biggest mistake is confusing volatility with risk and selling at the wrong time or buying precisely when they should be selling. Turbulence, or volatility, is a normal part of market behaviour. It’s probably more normal than the lack of volatility we saw in 2017.”
Predicting current conditions will continue until at least 2020, Doyle said volatility is important when selecting multi-asset strategies. It can provide good entry points to markets, at cheaper prices. “If you look at the weakness in the fourth quarter of 2018, it was tactically a good time to be buying risk,” Doyle said.
Although risk metrics are vital in the decision-making process, Doyle points out that those applied in financial markets are backward looking. This can obscure the real picture, since volatility might be going up, but risk may be falling (or vice versa).
Among the plethora of multi-asset strategies available, what counts is the detail within each strategy. An investment portfolio that aims to deliver CPI + 4-6%, cash + 3-5% returns (rolling 3-5 year periods), takes varying degrees of risk into the portfolio and does this in different ways. Key risk factors include equity beta, bond beta, alpha (including stock selection and asset allocation decisions) and factor risk, together with leverage and complexity risks.
“Basically, these are the six broad levers that managers can pull, and how they pull them can result in very different outcomes for investors ,” Doyle said.
Indicative risk loading for multi-asset strategies
As the chart (above) indicates, these strategies can be mapped, to reveal differences in risk, rather than less risk. It also highlights how each strategy loads each risk.
Doyle takes an objective-based multi-asset approach to assessing risk and protecting wealth in the current climate. Objective-based strategies target a specific outcome within a timeframe, rather than performance relative to a market index.
This same approach, is presented as a Real Return strategy in Australia (which has been operating for more than 10 years) and is known as a Target Return strategy globally (in aggregate, referenced as ‘target return strategy’), with the key difference being the currency in which they are managed. The global Target Return strategy has been operating for over 2 years.
Doyle’s objective-based approach draws on the insights and experience of Schroders’ Australia-based team, as well as the extensive resources of the broader Schroders global network.
The key feature is flexibility. Without a benchmark asset allocation, the target return strategy is unanchored and as such isn’t tied to movements in arbitrary benchmarks or equity markets. This strategy has broad ranges of 0-75% for equities and 0-100% for cash, defensives and opportunities sets i.e., equities, credit bonds, currencies, cross market trades and interest rate management. This flexibility allows the asset manager, as Doyle puts it, “to avoid those areas that are going to lose money for us and focus on those areas that will put us in the best position possible to achieve our return targets.”
“Since portfolios can’t deliver at US Libor + 5% with 100% certainty, risk is framed around loss. Every asset allocation decision is an active risk decision.”
Typically, static asset allocations suit bull markets where equity markets work well, and return on risk tends to be driven off equity, but in a bear or volatile market, this strategy is ineffective and lacks flexibility.
A traditional balanced portfolio may have a 60-70% exposure to equity, so equity risk will dominate. In the current climate, with headwinds for equities gathering, this also means a static-based allocation portfolio is likely to come under pressure, thereby impacting its ability to deliver positive returns.
“Objective-based strategies are flexible, active and maintain an appropriate level of liquidity. Its inherent flexibility means the asset manager is able to take advantage of opportunities as they arise which, going forward, are likely to be in currency and interest rates re-aligning,” Doyle said.
From a global macro-economic point of view, the asset manager sees signs of overheating in parts of the US economy with evidence that policy tightening has started to bite and profits have started to slow, adding to quite large geopolitical risk. In the year ahead, Doyle believes these conditions, combined with high levels of debt, could potentially create problems in loan markets.
Over the long term, Schroders is reasonably positive on Asia, backed by China’s growth but its caveats include volatility and the effect of government policy on market behaviour.
Summing up the current global market, Doyle sees not a lot of risk premium, valuations for most assets are on the demanding side with US equities among the most expensive; low credit spreads; and sovereign bond yields are also at low levels. “You’ve got demanding valuation and a fairly extended cycle but it’s not showing too many signs of late cycle cracks – it may still have some room to run.”
No matter what multi-asset strategy is chosen, there remains no easy path for targeted returns going forward, and investors will need to work hard to garner returns, all the while bearing in mind the old adage, “there’s no such thing as a free lunch”.
The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.This document is intended to be for information purposes only and does not constitute any solicitation and offering of investment products. Investment involves risks.
Source: AsianInvestor June 2019
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