Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Talib Sheikh, from JP Morgan explains why he thinks a multi-asset portfolio is best placed to face the challenge of fully valued market.
A decade ago the basic concept of a multi-asset income fund was dramatically different. Multi-asset funds evolved from traditional balanced funds, a mix of equities and bonds. Back then, it was pretty much just the basic binary decision between stocks and bonds. How much did you hold of each asset class as a reflection of your macro view? Fund managers were focused on timing the market through some combination of macro analysis and tactical models. Something they and the academic literature know is incredibly difficult to do.
However, in the last few years, multi-asset income funds have moved light years beyond this conversation. Today, it is all about managing an increasingly multi-dimensional and much expanded opportunity set. We would argue that evolution is precisely why multi-asset income funds will prove their value relative to other investment strategies in the immediate future.
Why now? With the benefit of hindsight, it’s quite clear that the last few years should have been a relatively easy time to be an investor. Virtually all assets rallied following the financial crisis for two main reasons. First, risk premiums were high and valuations were low. That risk premia has now all but disappeared across many asset classes. For example, we’re not overly bearish on bonds but it is hard to argue that much value remains in the sector.
Second, global markets have been overwhelmingly driven by a sea of abundant liquidity. The whole point of the unconventional intervention undertaken by many of the world’s central banks in the form of quantitative easing was to inflate the price of risk assets, force the risk premia to contract and make cash more expensive to hold. Whilst this has unquestionably served as a massive support function for the markets, it cannot continue forever.
With the first signs in evidence in the UK and the US, slowly we’ll begin to see a process towards normalisation in the price of liquidity. That is going to have profound implications for asset classes themselves and for the correlations between asset classes. Therein lies the benefit of a multi-asset approach, in its ability to navigate an increasingly fluid and rapidly changing opportunity set.
For a snapshot of how this can work in practice, we can look at last year’s taper tantrum episode, which showed that many portfolios carried significantly more liquidity risk and correlation risk than investors realised. A multi-asset fund concentrated on seeking less correlated returns with the ability to avoid sectors or securities where investors are not compensated for taking these risks presents a better opportunity to navigate such an environment.
The point of having an allocation to a multi-asset income strategy is not to maximise returns in the absence of any consideration of risk, but rather to maximise the opportunities for compelling risk-adjusted returns by expanding the opportunity set in the context of balanced diversification. That’s an important point if we step back to think about it in the context of the current market sentiment. We’re nearly five years into a bull market in equities and thirty years into a bond bull market. Equities haven’t just doubled, they have gone up 200%. That’s had an impact on investor mentality despite the risk aversion remaining post financial crisis. Many investors are thinking first about chasing yield and return, with less attention on the risk. Whilst we remain positive on risk assets overall and believe they can continue to do well from here, in our view running maximum levels of risk at these valuations and in light of the current macroeconomic backdrop is far from an optimal solution on a medium term investment basis.
There is a second major reason that multi-asset income funds are resonating. It has to do with the increasing realisation amongst investors, especially in Europe, that multi-asset income funds can replace what used to be the low risk part of their portfolios. What previously would have been an allocation to a traditional bond today is nearly unfeasible. Bonds are incredibly expensive and provide little income.
Remember as we stated the whole point of quantitative easing has been to push investors further out on the risk spectrum by making the returns of so-called “risk-free assets” marginal. This has left higher risk assets with greater valuation cushion as the only game in town. A multi-asset income fund able to incorporate these opportunities whilst balancing the volatility inherent in higher risk exposures is more and more being seen as a preferable foundation allocation.
A final proof point for the value of taking a multi-asset income approach lies in the tactical asset allocation these strategies can offer. Put simply, tactical asset allocation is about tilting a portfolio in accordance with the investor’s underlying risk profile.
That means buying things that you think are cheap and avoiding those that look expensive. In terms of how that’s reflected in our own positioning, that means we remain cautiously overweight to risk assets, albeit less overweight than we might have been several months ago. Nevertheless, we broadly continue to believe that a preference for equities over bonds is justified.
Multi-asset income funds should be well poised in the increasingly uncertain environment ahead to provide stable returns by identifying the most well rewarded investment opportunities across not just asset classes but geographies and capital structures.
Disclaimer
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