Valuation should be considered more in portfolio construction to help manage risk, Scott Gallacher, director at Rowley Turton, has said.
Looking at the investment landscape over 2022, Gallacher noted that rapidly rising interest rates and capital losses on fixed rate holdings threw into question the concept of low risk.
“However, it's important to remember that this will likely be a one-off event,” he added. “Moving forward, rates are unlikely to increase to the same extent, and today's higher yields will offset some of the pain of further rate rises.”
“That said, valuation is often overlooked when it comes to portfolio construction, and it's not as simple as mixing traditional low-risk and high-risk assets. Valuation may need to be considered as part of any portfolio construction exercise.”
The recent underperformance of bonds has meant that lower risk funds have often underperformed those that are higher risk.
However, the steep rise in yields now means that bond valuations are much more attractive, said Baylee Wakefield, multi-asset fund manager at Aviva Investors.
She added: “Nearing the end of the interest rate hiking cycle results in forward-looking returns that look much more attractive, particularly in areas where interest rate cuts are beginning to be priced.”
Rahab Paracha, sustainable multi-asset investment specialist at Rathbones, said that, “with starting bond yields much higher, we feel it is more appropriate for lower risk funds to have greater exposure to this asset class where the returns on offer are more attractive, and starting higher yields mean downside risk is reduced”.
Max Macmillan, investment director at Abrdn, said when looking at risk, it was not a question of whether high risk was higher risk than low risk, but whether it was the right framework to guide asset allocation.
Macmillan added: “High risk is not an asset class. Low risk is not an asset class. You can gain low volatility exposures to corporate risk – investment-grade credit spreads – and high volatility exposure to government bonds – ultra-long duration bonds with high interest rate sensitivity.
“We prefer to think along multiple dimensions. Risk and pro/counter-cyclicality. Assets can either follow the business cycle (equities) or hedge against it (bonds).
"Both can be deployed in high or low-risk expressions, by modifying the specific asset chosen, or else the magnitude of exposure to them in the fund.
“Similarly, there will be phases when monetary retrenchment is so stark that all assets underperform.
"Cash, commodities and select foreign exchange exposures are king in those periods, but again, the magnitude of risk deployed should be managed separately, as a function of risk tolerance, long-term asset return potential, and conviction/clarity."
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