Stuart Rumble, Fidelity International
Learning to live with volatility and uncertainty
It is of little surprise that investors around the world are looking for direction in how they manage their portfolios, both in the short- and long-term.
Although the late stages of an economic cycle tend to be associated with higher levels of volatility and drawdown risk, the recent period of extraordinary monetary policy and returns on capital has created a particularly challenging environment for investors. Markets, for instance, are characterised by compressed yields, stretched valuations in many areas and bouts of elevated volatility.
Several factors are shaping the immediate outlook. Among them is whether events in the US economy, like the low jobless claims, might force the Fed’s hand in reversing a dovish stance in place since early 2019. Just how carefully has the Fed managed expectations in relation to the future path of monetary policy?
Since the bond market has priced in a good chance of a rate cut in the next 12 months, any decision to raise rates again during this time will likely be a key source of volatility in markets.
From a geo-political standpoint, meanwhile, trade war rhetoric is softening and there are hints of renewed confidence among market players about the prospects for a US-China trade deal. Saying that, no announcement may dent global capital markets. Optimism is in especially short supply in relation to Brexit, however, as the uncertainty and frustration of no progress continue to weigh on sentiment.
For investors trying to read these and other developments, their struggle is made more difficult by the fact that, at times, both risk and defensive assets globally have become positively correlated when investors needed diversification to reduce portfolio risk.
It is a good time to evolve simpler approaches to portfolio construction by adding more levers for investors to pull in the bid to generate attractive returns while keeping risk under control.
This is where a multi-asset approach can deliver. And while it is a strategy always worth considering, today’s topsy-turvy markets make it an even smarter move.
Three tools for a smoother investment journey
In short, the benefits of multi-asset versus single-asset class strategies are clear: they aim to deliver pre-defined outcomes, often in the form of total returns or stable income streams within a specified level of risk.
In practise, investors get enough exposure to the potential upside of products like equities and high-yield bonds to generate good returns, plus have flexibility to avoid a serious loss of capital during spikes in volatility.
In particular, there are three effective multi-asset tools that help manage volatility:
Since a truly multi-asset strategy can give investors access to a wide range of asset classes, including non-traditional assets such as property, commodities or even infrastructure, it doesn’t suffer the constraints of funds that can only hold equities or bonds.
This relieves some of the pressure on a portfolio of having to rely on any single asset to perform throughout an economic cycle. Including more assets with low correlations to each other, as well as to traditional assets, is at the heart of diversification, which helps to reduce risk.
Although the relative weights of different asset classes within a multi-asset fund depend on the pre-defined outcome, the strategy can capitalise on the value of each asset’s characteristics – which are perhaps best represented via the graphic, which highlights performance features over the long-term:
2. Flexible investment ranges
The scope for a multi-asset fund to tactically adjust exposure to different assets at certain points in a market cycle is another key benefit of taking this approach.
Of course, each new market cycle can be different from the last, as can the relative performance patterns among asset classes. However, being able to make tilts, and doing so in a disciplined way, provides the flexibility to help smooth returns and enhance risk-adjusted portfolio performance.
3. Portfolio fine-tuning
The new generation of multi-asset funds offers additional tools to fine-tune positioning. Style rotation could be one of them, and the use of derivatives another.
Multi-asset portfolios can benefit from getting their asset class exposure by allocating to actively-managed strategies with different approaches.
This is another way for investors to adapt to various stages of a market cycle. For example, when an economy is rebounding from a recession, a multi-asset manager might allocate more to strategies that invest in smaller companies, given these firms can be nimbler and (often) less reliant on changes in policy, like interest rates.
Derivatives can be used to protect the fund from specific risks, such as a fall in the currency of an economy hit by political risk, or to improve the efficiency of portfolio asset allocation.
Blending a range of complementary styles and the prudent use of derivatives again adds resilience over the long term, plus reduces the impact of short-term spikes in volatility.
To learn more about Fidelity’s multi-asset solutions, please click here.