60-40 or bust
You have to feel somewhat sorry for today’s financial and investment adviser. Assuming you assist your clients in choosing discretionary investments, you have to navigate them through an absolute minefield of asset classes, investment methodologies, product types, product provider brands, etc. Case in point, if you decided to go the “easy investing” route of just focusing on unit trusts, nowadays referred to as Collective Investment Schemes (CIS) funds, you would have a choice of around 1 769 local funds… It should come as no surprise that advisers either go with ‘vanilla’ balanced funds or multi-asset funds to get the job done.
Is the balanced fund dead, deceased or just resting
Unfortunately, multi-asset funds had a rough time of it last year. So much so, that in his presentation to The Investment Forum 2023, Michael Devereux, a Multi Asset Portfolio Manager at Schroders, was tasked with answering the following riddle: Is the 60-40 dead? The 60-40 is a reference to the mainstream multi-asset management approach of allocating around 60% of assets under management to equities, and the balance to bonds and cash. In a refreshing turn of events, Devereux did not make the audience sit through his entire 30-minute presentation before answering this question with an emphatic no. “There should be a much better year ahead [for multi-asset] or so-called 60-40 strategies, based around the key assumption of inflation peaking,” he said.
Wow, just 30-seconds or so to answer the headline question and bring up the inflation and interest rate bogey men! It turns out that the first requirement for multi-asset funds to outperform this year is for inflation to cool down. “Looking at the big picture [we see global] growth slowing, inflation peaking and a more normal year ahead, [perhaps even delivering a] softer landing environment, which is traditionally pretty good for 60-40,” said Devereux. The caveat is that there are many risks, known and unknown, lurking beneath the surface. An example of such risks was the sudden ‘drama’ that unfolded at SBV and Signature Bank in the United States. After acknowledging the risks, Devereux advised that there were still opportunities in the bond and equity asset classes, before adding that investors could not afford to ignore the potential in commodities and currencies.
Valuations drive asset allocation decisions
It turns out that value is still central to asset allocation decision making. At the start of 2023, global treasuries and emerging market debt looked “better than they have for many years”. And US equities offered cheaper entry points than they had at their 2022 peak, though this was not a signal to rush in… “The 60-40 portfolio rarely suffers the extent of the drawdown we saw last year; for both equities and bonds to decline at the same time is pretty unusual,” commented Devereux. It is also rare but not unheard of, for a 60-40 combination of bonds and equities to deliver negative returns in two consecutive periods. For the record, a combination of US bonds and equities delivered negative 19% last year.
Economic and investment analysts’ 2023 outlook discussions have centred on the type of landing that the US economy is likely to experience. “For most of last year we thought we were in for a hard landing … because that is what has happened in many business cycles; high rates come with a drop in inflation and growth,” Devereux said. This hard landing view is understandable given how aggressively the US Federal Reserve hiked interest rates: the federal funds rate rocketed from 0.25% in March 2022 to 4.75% by February 2023. Fortunately, the US and global economies proved more resilient than expected, absorbing rate hikes without going into freefall. “We are currently looking at a soft landing in the middle of this year,” he said. Inflation is coming down from its peak, growth is coming down; but because of the excess ‘supply’ of savings and government support there is enough “fuel” to take the economy on a shallower glide path.
Risky assets love a soft landing
A soft landing is apparently good for riskier assets such as bonds and equities. “Falling inflation is necessary for a multi-asset portfolio to reap its diversification benefits,” said Devereux. He explained that developed markets were currently in a “positive growth momentum and high inflation environment” which should be good for equities, and bad for pretty much everything else… The elephant in the room is the transmission mechanism between the Federal Reserve’s inflation fighting mechanism (interest rates) and economic growth, and analysts warn that it is not always clear when or how severely contracting balance sheets and slower credit and money supply will be felt. Devereux described this effect using the phrase “slowly, slowly – all at once”. Or, alternatively, you wait for ages for a bus, and three show up at the same time.
Outside of bonds and equities, commodities and currencies have popped up on Schroders’ multi-asset team’s radar. The outlook for commodities is somewhat contentious with many warning that the demand that supported commodity prices through 2021 and 2022 is fading. The workaround for this is to position in the right ‘pockets’ within the commodity universe. “Even though commodity prices have slid quite a bit, there is still a BREAK case to say that they belong in a portfolio,” Devereux said. Gas and gold cracked a nod as portfolio diversifiers; but not much was said about South Africa’s staples coal, copper, iron and platinum group metals (PGMs). As for currencies, the presentation noted that the US dollar was trapped in a period of dollar weakness.
Could 2023 be a very good year?
The good news for financial and investment advisers is that their clients should see better outcomes from balanced and / or multi-asset funds this year. “60-40 should have a much better year,” concluded Devereux. “The bond side definitely had a much better time after experiencing unprecedented two- and five-day changes … but overall, the peak in inflation and declining volatility should mean the 60-40 has a better time”. Schroders still sees opportunities in equities, though they are more interested in markets ex-US, and companies that fit with a mixed “quality and value” investing style. And the cherry on top; well, that should come courtesy of diversification into commodities and currencies.
Writer’s thoughts:
As one explores the world of asset management, asset allocation and fund choice, it becomes apparent that even global firms with hundreds of analysts and experts on their payrolls face challenges in investment decision making. In this context, it seems near impossible for small financial advice practices to get market ‘calls’ right. Are you still going it alone when selecting funds for your investment clients, or have you gone the Discretionary Fund Managers (DFM) route? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
