The value of investment and the income from them can fall as well as rise and are not guaranteed. The investor may not get back the amount originally invested.
Multi-asset investing is about owning different asset classes at the same time. This much seems obvious. It has tended to work because equities and bonds have moved in different ways. While one zigs, the other might zag. The start of 2022, however, has posed a challenge to this principle as correlation between equities and bonds (i.e., the degree to which they move in relation to one another) has moved higher and crossed into positive territory.
Often bonds have gone up when equities go down, because when economies are slowing and the world seems like a scary place, investors seek out safe assets, especially those that benefit when central banks cut interest rates (as they have often done in economic slowdowns). But so far this year, equities haven’t fallen because of fears of an imminent recession. On the contrary, economic growth is very strong. Equities are falling because investors believe that central banks around the world may hike interest rates fast and far, perhaps faster than ever before. This pushes down the present value of your expected future equity cashflows. But worse – it pushes down the present value of your bond cashflows as well.
So, what can we, as multi-asset investors, do when equities and bonds are moving down in sync, and it seems like there is nowhere to hide?
Today’s market environment calls for a different approach to diversification – one that includes seeking out asymmetric sources of return (i.e., investments where potential upside is greater than potential downside) including a variety of hedging strategies. We need to be targeted and precise in the expression of our views to deliver outcomes for clients. One solution remains within equities and bonds. You don’t necessarily have to be long! You can look for areas of the market that seem overvalued and take the other side of the trade so that you benefit when their value falls. A simple way to do this is by selling index futures, an investment that increases in value as the price of the index falls. Our extensive investment toolkit also means we can create custom indices if we have a view that a specific sector or style of company is challenged. For example, early-stage unprofitable technology companies can be especially vulnerable to rising interest rates as the prospect of profits in a far-off future seems less appealing when the cost of capital is rising. We can create a bespoke structure to express this view with more precision in a liquid and low-cost way.
In other cases, there may be certain macro or geopolitical events, particularly those with a binary outcome, that we expect to be important but difficult to predict. Examples include policy decisions, elections, and even major corporate earnings. In those circumstances, rather than taking a view on market direction, we can employ volatility hedges where returns are dependent on how much asset prices move. The question we ask ourselves here is not, “Do we believe these assets will move up or down?” but rather, “Do we believe the price of assets will move a lot?” Our broad investment universe also affords us the flexibility to look beyond traditional equities and bonds. Real estate and infrastructure are both vast asset classes, sometimes lumped together under the loose heading of “alternatives” – but as our BlackRock Alternative Investors colleagues have often noted, perhaps these should be treated more as core assets. As a team, we make extensive use of them in our portfolios. In real estate, we have identified opportunities to invest in social housing assets via real estate investment trusts (REITs). These allocations offer well-diversified exposure to long-term inflation linked leases with approved providers in receipt of direct government funding. Such investments therefore fulfill a key societal need through housing vulnerable residents whilst also offering a welcome source of diversification to the portfolio.
We also favor investments in renewable energy infrastructure, which is exposed to different risk and return drivers than those that steer equity and bond markets. How much the sun shines or how strongly the wind blows, for example, have historically exhibited low correlation with broad equity markets. Renewable-energy investments also often have revenues that are explicitly linked to inflation and are therefore positioned to protect value in real terms. Sustainable assets that perform well in an inflationary, lower growth environment should, in our view, play a fundamental role in multi-asset portfolios.
Read the full report here: BlackRock
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