Rethinking ‘Safe Haven’ Assets In A Multi-Asset Portfolio
October 5, 2015
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Over the last 18 months, the Invesco Multi Asset team has maintained that the lack of volatility in several markets versus historical norms was providing interesting investment opportunities. At the start of the year, we published a blog reinforcing our belief that volatility was an undervalued asset class (Investing in Volatility: Is Asian Volatility Poised to Rise?) and specifically addressed Asian equity market volatility and how the region’s fundamentals appeared to be pointing toward a storm on the horizon. In the last several weeks, that storm has blown in — we have not only seen a resurgence of volatility in many equity markets, but we have also, once again, seen signs that yesterday’s playbook with respect to portfolio diversification may not apply in the current market regime.
‘Safe haven’ assets are acting more like equities …
Markets began their tumultuous journey downward toward the end of June, driven by déjà vu worthy headlines around Greek debt and exacerbated by familiar fears over a Chinese slowdown and hard landing. During this period Asian equity markets were particularly hard hit, with the Hang Seng China Enterprises Index (HSCEI) falling 38.5% from its peak in May, for example.
To offset the impact from falling equity markets, investors often look toward “safe haven” assets such as government bonds and exposure to the US dollar, and may also shift their preference to defensive stocks versus cyclicals, and to US markets versus their riskier counterparts. However, most recently we have seen correlations rise between equities and the traditional perceived “safe haven” assets of government bonds and the US dollar, indicating their ability to diversify portfolios during periods of equity market stress is being challenged.
… but volatility may help provide diversification
Historically, volatility has been a strong positive performer in the face of significantly falling equity markets. For this reason, we believe that volatility can be an effective tool for multi-asset portfolios, especially in a market environment where conventional asset allocation wisdom with regards to “safe haven” assets is being challenged.
Recently, we saw Chinese equity volatility, measured using an HSCEI three-month volatility instrument, spike from a relatively benign level in the mid-20s, where it had rested for most of the year, to above 52 at the start of September. This movement was exacerbated by large market players, such as investment banks, quickly becoming buyers of volatility instruments. Those who capitalized on the strong move in Chinese equity volatility were able to help offset the drawdown felt by exposure to Chinese or related equity markets during the sell-off.
Taking a view on volatility
A central tenet of the Invesco Multi Asset investment philosophy is that true diversification comes from an unconstrained approach to asset allocation. This enables us to take a view on the volatility of different markets, and express that view through instruments that allow us to isolate volatility as a distinct asset type. We believe this is invaluable in terms of diversification.
How do we do this? We look for areas where we think that the relative risk implied by markets presents an opportunity. This can be expressed through paired investments in a single asset class—for example, we can express ideas that by design could benefit from an outperformance of Asian equity risk versus US equity risk, and, similarly, by an outperformance of the risk of the Australian dollar versus that of the US dollar. Or, we can look across asset classes. For example, we have ideas designed to capitalize on the relative volatility of UK equities and UK bonds. As with any idea in our portfolio, these volatility ideas are supported by specific macroeconomic themes and fundamentals – the first two ideas referenced above are tied to the China slowdown; the cross-asset UK idea is backed by the potential distortion created by Central Bank monetary policy.
Additionally, we can exploit the diversification qualities of volatility by embedding exposures within an equity-based investment idea. By adding long exposure to the volatility of various equity markets alongside allocations to equities, we believe we can at least partially offset the portfolio’s exposure to a significant equity market drawdown, without meaningfully jeopardizing our ability to capture the upside of a positively trending equity market environment.
It is important to note a few things about investing in volatility instruments:
- While volatility may provide an additional diversification resource to investors, it is by no means a panacea — investors shouldn’t expect volatility instruments to completely replace other diversifying assets. Rather, they may be viewed as a complement due to their distinct qualities in a significant market selloff.
- Additionally, volatility opportunities must be thoroughly evaluated, especially in markets where indiscriminate volatility sellers seeking income may overwhelm normal market dynamics.
- Lastly, sometimes the best way to get attractive exposures to volatility may come from more sophisticated derivative markets that are not accessible directly by all market participants. Therefore, it is important to choose a manager with experience evaluating and trading in these markets.
We encourage investors to talk to their advisors about multi-asset strategies, and to do their homework into the experience of their fund managers. For Invesco Global Targeted Returns Fund, you can start here.
Danielle Singer, CFA Senior Client Portfolio Manager1
Danielle Singer is a Senior Client Portfolio Manager for the Invesco Multi Asset team.
Before joining Invesco in 2014, Ms. Singer was a strategist and director of the Global Investment Solutions (GIS) team at UBS. Her responsibilities included participating in the review and setting of multi-asset and currency strategies, interacting with the investment team to coordinate investment strategy, and assisting clients as part of the GIS initiative. Previously, Ms. Singer was an account manager for UBS’s Institutional Investment Management group, where she maintained client portfolios and presented investment reviews. Prior to joining UBS in 2004, Ms. Singer worked on the auction rate securities desk at Deutsche Bank.
Ms. Singer earned a BA degree at Middlebury College and an MBA at the University of Chicago with concentrations in analytic finance and econometrics. She holds the Series 3, 7 and 66 registrations. Ms. Singer is a CFA charterholder and a member of the New York Society of Security Analysts.
1 Not involved in managing assets of any fund.
The Hang Seng Index is an unmanaged index considered representative of the Hong Kong stock market and includes the largest companies traded on the Hong Kong Exchange.
The Hang Seng China Enterprise Index in an unmanaged index tracking the performance of mainland China companies listed on the Hong Kong Exchange (known as H-shares). An investment cannot be made into an index.
Diversification does not guarantee a profit or eliminate the risk of loss.
Past performance is no guarantee of future results.
Correlation is the degree to which two investments have historically moved in relation to each other.
Volatility measures the amount of fluctuation in the price of a security or portfolio over time.
A hard landing is when an economy sharply slows down after a period of quick growth. This can be the inadvertent result of government or central bank attempts to keep inflation in check.
The fund seeks diversification through exposure to different asset types, but has non-diversified SEC classification.
Please note there is no guarantee this performance target or volatility target will be achieved.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
There is a risk that the Federal Reserve Board (FRB) and central banks may raise the federal funds and equivalent foreign rates. This risk is heightened due to the potential “tapering” of the FRB’s quantitative easing program and other similar foreign central bank actions, which may expose fixed income investments to heightened volatility and reduced liquidity, particularly those with longer maturities. As a result, the value of the fund’s investments and share price may decline. Changes in central bank policies could also increase shareholder redemptions, which may increase portfolio turnover and fund transaction costs.
Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.
Debt securities are affected by changing interest rates and changes in their effective maturities and credit quality.
Derivatives may be more volatile and less liquid than traditional investments and are subject to market, interest rate, credit, leverage, counterparty and management risks. An investment in a derivative could lose more than the cash amount invested. These risks are greater for the fund than most other funds because its investment strategy is implemented primarily through derivatives rather than direct investments in more traditional securities.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The fund is subject to the risks of the underlying funds. Market fluctuations may change the target weightings in the underlying funds and certain factors may cause the fund to withdraw its investments therein at a disadvantageous time.
Leverage created from borrowing or certain types of transactions or instruments may impair liquidity, cause positions to be liquidated at an unfavorable time, lose more than the amount invested, or increase volatility.
The fund is non-diversified and may experience greater volatility than a more diversified investment.
Short sales may cause an investor to repurchase a security at a higher price, causing a loss. As there is no limit on how much the price of the security can increase, exposure to potential loss is unlimited.
The fund may invest in derivatives either directly or, in certain instances, indirectly through Invesco Cayman Commodity Fund VII Ltd., a wholly owned subsidiary of the fund organized under the laws of the Cayman Islands (Subsidiary). Because the Subsidiary is not registered under the Investment Company Act of 1940, as amended (1940 Act), the fund, as the sole investor in the Subsidiary, will not have the protections offered to investors in US registered investment companies.
Underlying investments may appreciate or decrease significantly in value over short periods of time and cause share values to experience significant volatility over short periods of time.
The fund is subject to certain other risks. Please see the current prospectus for more information regarding the risks associated with an investment in the fund.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
Before investing, investors should carefully read the prospectus and/or summary prospectus and carefully consider the investment objectives, risks, charges and expenses. For this and more complete information about the fund(s), investors should ask their advisors for a prospectus/summary prospectus or visit invesco.com/fundprospectus.
All data provided by Invesco unless otherwise noted.
Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. PowerShares® is a registered trademark of Invesco PowerShares Capital Management LLC (Invesco PowerShares). Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.
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