Emma Wall: Hello and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by John Husselbee, Head of Multi-Asset for Liontrust.
Hi, John.
John Husselbee: Hi.
Wall: So, we're here today to talk about multi-asset, which is your bag and talk about how asset allocation is incredibly important in order to achieve the aims that you have as an investor. It's not as simple as choosing one fantastic stock, one fantastic bond, one high-paying cash account. It's the blend which really can determine investment success, isn't it?
Husselbee: Most definitely. The blend determines success. If you want to play defense against the market or if you want to play attack against the market, the long-term is the key and what you have to work out is what each of those asset classes, equities, bonds, alternatives, and cash, what they are doing for you in your portfolio and get the right blend as you said.
Wall: Let's take equities then for a starter. What does equities add to a portfolio?
Husselbee: Well, equities are the main driver of growth for your portfolio. So, over the long term studies have said that equities outperform bonds, outperform cash. So, equities are the main driver of your portfolio. But there's a price to pay for that and that price is volatility and we see that more than once or twice a year. So, equities are good for the long term but the price you pay is volatility.
So, the blend is important and that blend we call diversification, so using other asset classes which act and behave in different ways to try and smooth out that ride in equities. So, you can invest 100% of your portfolio in equities, but you've really got to think about the long-term for that because it can be a pretty bumpy ride.
Wall: The traditional sort of marry to equities is of course bonds. What does bonds bring to a portfolio?
Husselbee: Well, bonds provide traditionally, I should say, because I think it is right – traditionally, bonds have provided you with income, steady income and they have also provided you with price stability. Price stability in terms of actually, as you said, being a good blend with equities. So, when equities maybe rising, bonds maybe falling and vice versa. So, it's given you good diversification in your portfolio and helped smooth out that bumpy ride that I was referring to.
Wall: And it's not just about bonds and equities, is it? You have some things such as cash for liquidity and alternatives to provide an extra sort of uncorrelated boost?
Husselbee: Yes, definitely. I mean, cash – so your traditional asset classes in a portfolio, equities, bonds and cash. So, equities drive the performance, the long-term growth; bonds give you income, price stability, some diversification; and cash traditionally has been used for capital preservation. So, if you feel that you want to preserve some capital, normally you run for a safe haven, that's typing being cash.
And as you said, alternatives have now become quite popular. They've become quite popular where we are in the investment cycle. That is, we're in a low inflationary environment but bonds are low as well. So, therefore going forward, perhaps the job that bonds did in the past, price stability in particular, may not be able to do that in the future. So, as you know, this industry never sits still. There's innovation all the time and we've got some new asset classes and funds in the alternatives sector.
We might break them into two. So, you've got alternative absolute return funds and then you've got hedge funds. And if I just sort of explain what my definition is because there are plenty out there and I'm sure if you look on the Internet, you'll find many definitions; but for me, absolute return funds. These have low correlation, in other words, they don't act exactly the same as equities, bonds and cash within the portfolio, have a low correlation to the traditional asset classes, but they look to reduce risk within your portfolio.
Whereas it comes to hedge funds, these things still have low correlation, no correlation, but they look to enhance your returns because they are looking through different techniques to get a different type of growth, a different type of capital growth. So, alternatives are becoming a growing part of client portfolios.
Wall: You touched on it there, portfolio construction one-o-one suggests you have X percentage in cash, X percentage in bonds, X percentage in equities, but of course that assumes a market that only goes one way and that is up. We have had bond prices rising for over a decade now and we are entering into quite a different environment for bonds. So, how much does the market backdrop determine what one should hold in one's portfolio?
Husselbee: There are two key drivers of portfolio construction when I'm looking at it. I've been running money now for 30 years. The two key things you've really got to keep an eye on is the path of growth, global economic growth and the path of inflation. That determines really the construction of your portfolio.
In an inflationary environment it's a totally different portfolio to one of a deflationary environment. So, as you quite rightly said, we've been in an environment for quite a long time now, it's a bit of deflationary environment. Inflation has been coming down. In that period bonds have performed extremely well. Perhaps as we turn around, I know there's not much inflation around at the moment, but there is a target of 2% for the Bank of England and there's a target of 2% for most of the central banks around the world.
It rather suggests that inflation will start coming back. The way unemployment has fallen, I suggest it's around the corner, whether it's in the next year or so, inflation will start to come back. So, therefore, you need to basically be moving your portfolio around to reflect that and that will probably mean at the moment perhaps more equities and also perhaps more alternative assets whether that's absolute return funds or hedge funds. But avoiding bonds to some extent, you still need bonds in your portfolio.
I think one thing that perhaps sometimes people, clients find it hard to understand is that your portfolio you'll have equities, bonds, alternatives in there and you look over a period of time and yes, some of those investments would have fallen and others would have gone up. Sometimes it's actually best to look at the whole portfolio rather than the individual part. I think if you start looking at the individual part, you start throwing things out which actually have played an important part within your portfolio to reduce volatility.
Wall: John, thank you very much. This is Emma Wall for Morningstar. Thank you for watching.
This article was originally published in 2015
