One of the challenges for money managers at present is undoubtedly centred on how to invest in the current low-growth environment.
The risk and return behaviour of traditional asset classes has undergone a step change away from the patterns we have experienced before. In the past, we saw large swings in asset returns, but overall markets provided very strong long-term results.
Unless one was unfortunate enough to deploy capital in equities at the very peaks of 2000 or 2008, then stocks, which make up the lion’s share of traditional multi-asset portfolios, have done very well for investors.
Furthermore, investors in fixed income markets have benefitted exceptionally from a persistent bond bull market in the past several decades, if not longer. Many macroeconomic factors underpinned this performance and, of course, sub-asset classes varied.
However, corporate sales grew, which increased earnings and left plenty of space for capital expenditure and future growth. Investors were tasked with an apparently more straightforward role of picking from the many rising asset classes that best suited their clients’ needs. Investing in the past few decades will certainly not have felt easy, but with hindsight, investors may need to admit they have benefitted from a particularly benign status quo.
In contrast, current low-growth conditions demand more stringent investment criteria, as broad beta exposure is unlikely to reward investors for risk, at least not at the level they have grown used to.
Despite my best intentions not to quote Warren Buffet: “only when the tide goes out do you discover who’s been swimming naked”. We should consider the implication of most asset classes offering poor to negative future returns and position portfolios accordingly, but there is no silver bullet; the needs of the client will largely dictate which path to follow.
While all multi-asset portfolios should target income generation, capital growth, capital protection and volatility dampening to various degrees, clients have specific needs and aspirations for their money that will drive the relative focus.
Before examining specific asset classes, the over-arching theme of low growth investing should be to take a fresh look at all asset classes in general, and re-evaluate whether they continue to provide the traditional risk/return profiles they showed in the past.
For example, sovereign debt historically provided total capital protection and moderate yields, but by mid-2016, roughly 30 per cent of all government bonds were trading at negative yields, guaranteeing investors losses from their investments. In the Eurozone closer to 50 per cent of all outstanding bonds were trading at negative yields. This was primarily led by government bonds, but was swiftly followed by corporates issuing at negative or flat yields.
Therefore, it is crucial that investors reconsider their rationale for holding sovereign debt and thoroughly scrutinise why it may be useful to hold such an asset. Investors should minimise their exposure to assets whose potential for return is entirely driven by a ‘greater fool’ theory, as these expensive assets have a long way to fall.
