Balancing risk has been extremely challenging over the past 18 months as the traditional metrics for assessing risks among different asset classes has been fundamentally affected by rising inflation, rising interest rates and weaker economic growth.
Last year both equities and bonds performed poorly at the same time, which meant bonds were unable to provide sufficient protection and diversification to multi-asset portfolios when managers needed it the most.
Many ‘alternative’ assets also struggled in this environment.
This is why Rahab Paracha, sustainable multi-asset investment specialist at Rathbones, says when thinking about portfolio construction, she allocates a certain amount of the portfolios to assets considered to be genuine diversifiers.
These are assets where the return profile requires no particular directionality from equity markets, and can provide positive returns even during periods of market distress.
She adds: “We often use structured products that take advantage of specific market dislocations unrelated to equity market performance.
“For example, we own a commodity curve note, which should perform positively as the commodity curve shape returns to its normal state, following significant disruption in commodity markets last year.”
Rathbones also targets investments designed specifically to provide portfolio protection in order to reduce or offset equity risk, for example, put options.
“These are in effect insurance contracts that can provide guaranteed protection in equity market sell-offs,” Paracha adds.
“Over the past few years, we have invested in a number of put options and put spreads on the S&P 500 to protect against weaker equity markets, using them more actively when bond yields were low, recognising that they were less likely to provide protection to portfolios from that starting point.”
Shifting opportunities
Max Macmillan, investment director at abrdn, says in a high inflation environment, .It is important not only to be thinking of including real assets, commodities and cash allocations therefore, but also to be managing them dynamically versus the more traditional bonds and equities in order to successfully navigate through inflationary episodes.
Macmillan adds: "In a high inflation environment, macro conditions are volatile. There are phases of rapid nominal growth followed by monetary retrenchment, and while the overriding or emergent victors may be commodities and cash, each phase will have a dramatically different pattern of market returns.
"It is important not only to be thinking of including real assets, commodities and cash allocations therefore, but also to be managing them dynamically versus the more traditional bonds and equities in order to successfully navigate through inflationary episodes."
High inflation will lead to higher rates. But as we move through a cycle, Kelly Prior, investment manager in the multi-manager team at Columbia Threadneedle, says the advantageous opportunity available for active management will change.
Prior says: “It is important to recognise that inflation is a moving, backward-looking measure. It is the kryptonite of bond investing, eroding both the value of the capital base, but also the value of fixed future cash flows.
