In Choppy Markets, Consider Casting A Wider Net by Martin Atkin

Income is scarce. Global growth is sluggish. Tomorrow’s returns may not match yesterday’s. All of this can make it seem like there’s no way to get ahead. We think a holistic, diversified approach can help.

Investors today are facing some harsh realities that can make it seem impossible to meet their investment goals. For example:

  • Unconventional central bank policies in developed countries and slow growth have kept bond yields low. In Japan and Europe, negative yields mean investors are actually paying governments—and even some corporations—for the privilege of lending to them.
  • Many assets are set for a run of below-average returns (Display). For example, after a seven-year bull run, developed-market equity valuations, including price-to-earnings multiples, are above historical averages. That will likely dampen future return potential.

Choppy Markets, Investment Returns, Unwanted Risks

Choppy Markets

Many market participants have responded by tearing up their investment playbooks and starting from scratch. For income-seeking investors, that’s often meant loading up on the highest-yielding assets they can find—and leaving themselves vulnerable when markets decline. Many growth investors, meanwhile, have soured on active management altogether and embraced passive strategies instead.

We think a more selective approach would work better, especially now that markets are getting more turbulent and less predictable. In our view, a nimble, diversified strategy that mixes tactical allocations with a broad universe of investments would do more to help outcome-oriented investors achieve their goals.

Widening the Opportunity Set

These types of multi-asset strategies can be designed with a particular objective in mind—and managers can go anywhere in the global capital markets to meet it. That can include using active and passive strategies, as well as nontraditional alternative strategies that can tap a wider investment universe to produce alpha. More importantly, every strategy and asset class must contribute to the overall investment objective.

For investors seeking a targeted return within certain risk boundaries or a specific level of income, this unconstrained approach makes more sense than one that limits them to parameters set by a single benchmark.

Avoiding Unwanted Risks

Being able to capture opportunities quickly wherever they arise is important because financial markets are becoming less predictable. A shaky growth outlook, China’s slowdown, the surprise Brexit vote in the UK—all have boosted volatility and investor unease this year. The result: no asset class has consistently outperformed the others this year.

Investors who focus too narrowly on a handful of assets can get into trouble. For instance, investors who need steady income might choose a simplistic mix of high-dividend stocks and high-yield bonds. This approach can provide a hefty income during calm stretches. But because each component is highly correlated to broad stock market moves, the strategy can be hit by big drawdowns when sentiment sours.

Diversification Still Works

In the past, few investors doubted that diversification of this sort improves returns and reduces losses over time. But in recent years, diversification has been getting a bad rap. The reason is simple: over the last few years, stock markets—particularly in the US—have moved in one direction: up. The S&P 500 Index rose nearly 250% on a total return basis between March 2009 and mid-2015. Investors who diversified away from stocks paid for it with lower returns.

But no asset class wins all the time, and those multiyear bull runs seem to be winding down. Developed equity markets have been flat or lower over the past year, while other asset classes like high-yield bonds and emerging-market assets are looking up. Investors with concentrated exposures—either to an asset class, a region or a benchmark—may have suffered.

We think these increasingly volatile conditions will be the new normal for markets in the years to come—and multi-asset strategies with their inherent diversification are designed to thrive in these environments.

Self-Assembly Not Required

But the do-it-yourself approach doesn’t always work. Investors who try to stitch together multiple single-asset strategies in one portfolio may find it hard to see how all the pieces fit together, exposing themselves to unknown risk.

Also, investors who slice up their allocation into many different silo-like strategies may not be able to identify and capture relative-value opportunities quickly. A well-constructed, integrated and dynamic strategy offers managers a more holistic understanding of relative risks and returns and can help improve the chance of meeting an investor’s goals.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.