Outlook 2018: Multi-asset
We are focused on generating returns while the going is good, but also remain alert to any sign that the benign backdrop may be changing.
1 December 2017
The global economy is experiencing its most synchronised expansion since the global financial crisis and, in tandem with the economic upswing, the outlook for corporate profits also appears favourable.
This supports our positive view on equities and the stance we have taken via our exposure to emerging market assets.
In fact, over the summer we increased our cyclical exposure further through investments in US banks and US small caps that should benefit from any upside surprise from US fiscal policy.
On the other hand, we believe that investors are paying too high a price for growth stocks and we are therefore avoiding them.
Will inflation and interest rates stay low?
The obvious risk to our benign outlook is that asset valuations are stretched. Valuations on their own do not predict returns on a one-to-three year time horizon, but they are an important indicator of risk and probability of loss. So far valuations have been underpinned by low inflation and low interest rates.
Critical to our strategy as we close 2017 is that inflation and interest rates remain under control. Although inflation may experience some cyclical increase, we do not expect it to get out of hand, due to a combination of demographic and technological factors.
We therefore expect the process of monetary policy normalisation to be gradual. Nevertheless, the economic cycle is entering its later stages and we expect to become progressively more cautious in 2018.
For now, we have established hedges against higher inflation and more aggressive central bank liquidity withdrawal by buying US inflation-linked bonds and favouring the US 30-year bond versus the US 10-year bond. Our strategy of favouring relatively undervalued assets also reduces our interest rate sensitivity.
Currency positioning is crucial
The US dollar has been an important trend to predict this year and, having shifted to a negative position in the US dollar for the first time this decade earlier this year, we have benefited from its decline. We continue to like emerging market currencies as they offer attractive yields.
At the beginning of 2017, we downplayed political risk and we have continued to emphasise the need to generate returns while the going is still good. This remains our strategy as we head into year-end.
Nevertheless, our focus on generating returns should not be confused with complacency: we are ready to move to a more defensive stance and are carefully monitoring our valuation and cyclical indicators.
Seeking new sources of diversification
Finally, given structurally lower expected returns on many asset classes, we are making increased use of alternatives to diversify our portfolios. These include factor-based alternative risk premia1 such as momentum that can earn positive returns in both up and down markets.
By allocating actively across return-seeking, risk-reducing and diversifying strategies we believe investors have the opportunity to earn returns no matter what 2018 brings.
A related article published today, which may be of interest, was Outlook 2018: Multi-Manager, by Marcus Brookes, Head of Multi-Manager, and Robin McDonald, Fund Manager, Multi-Manager.
1. Factors are the drivers of returns in asset classes. Macroeconomic factors capture broad risks across asset classes while style factors help explain returns and risk within asset classes. One such style is momentum, which signifies assets with upward price trends.↩
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