Over the last few years, investors have benefited from a desirable mix of high returns, low volatility and low correlations. Volatility and correlations are set to rise given a maturing economic cycle, a tightening of global financial conditions and an increased risk of protectionism, believe Remi Olu-Pitan, Multi-asset Fund Manager, and Clement Yong, Multi-asset Analyst, both Schroders.
This combination of factors – some of which form our Inescapable investment truths for the decade ahead – will likely see financial market volatility no longer suppressed and a possible end to low/negative correlations. Against this backdrop, we believe returns are going to be much harder to achieve and will require investors to take on more risk in order to achieve them.
Our framework puts forward several approaches that investors may find useful in navigating this environment. For investors that have the capacity and time horizon to embrace higher risk, we suggest considering:
- Increasing allocation to laggards such as emerging markets (EM)
EM can offer a higher premium than developed markets but are generally more volatile and may require a long-term view
- Increasing allocation to active managers
This can allow investors to tap into alpha potential, although alpha is not guaranteed and can vary over time
- Adding leverage
Leverage can help enhance returns as it magnifies portfolio positions but can lead to excess risk taking
Some investors will be unwilling or unable to take on higher risk. In these cases we propose narrowing the range of potential outcomes and smoothing the path of returns by:
- Allocating to private assets
Private assets can be genuine diversifiers given they are less correlated to traditional asset classes. However, they require significant resources and a long-term horizon
- Adopting a minimum volatility equity strategy
This strategy involves investing in low volatility stocks. However, it is predicated on one measure of outperformance (volatility) and ignores fundamental variables such as valuations, quality and interest rate sensitivity
- Using a multi-asset strategy
Multi-asset strategies which are truly flexible in their approach and balance the trade-off between returns and the range of outcomes well can generate alpha. Strategies that solely target a low to zero correlation to equities are likely to sacrifice returns. One therefore has to be discerning when assessing multi-asset strategies.
The best sailors are ones that can spot a storm from afar and are also able to navigate their ships accordingly to avoid the worst of the tempest. We believe that this is no different for investors, and it is imperative to accept the uncertain future and begin preparations on how to navigate through it.
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This article has first been published on schroders.com.