29 March 2016

Reshaping multi-asset portfolios for volatile times

Investors are understandably worried, with asset markets unpredictable and, in some cases, highly irrational. This is clearly a tricky time in which to invest.

As multi-asset managers, we need to walk a fine line. On the one hand we know that opportunities emerge when markets are less rational and we have to ensure that we can seek to capitalize on those situations.

But we also aim to protect our investors from significant swings in the value of their investment, keeping an eye out for surprises both nasty and welcome. The overall aim is to keep long-term income and capital returns as safe as we can by closely managing risk, keeping our response considered and in line with our long-term view.

Our response

Our overall response to the recent market turmoil has been to reduce exposure to volatile assets. We have cut equity exposure and increased our weighting in higher quality credit. At the same time, we have focused on emerging value in selected areas. Markets may not be universally attractive, but the sell-off since the start of the year - with the MSCI World Index down 11.5% in the first six weeks - has created some real opportunities.

Our view has been that 2015 was a transitional year, moving from a higher return potential environment in 2014 to a situation where investors had to select their asset classes carefully and be a lot more aware of the impact of volatility.

So far in 2016, we see disparity in the potential returns between different asset classes continuing. This is reflected in our portfolios, with a preference for credit over equities. We believe that, relative to equities, there is now more upside in certain carefully selected parts of the credit market, with less downside risk – a reversal of the situation in early 2015.

Our portfolios tend to have a quality bias and our credit exposure in 2016 will likely be no exception. We are not going bottom-fishing. Trawling around in high yielding CCC bonds of oil services companies proved a disastrous trade for many non-cautious investors in 2014 when these bonds declined significantly, in some cases more than 23%.

We believe this market could be equally painful this year. However in our view, some other parts of the high yield market – notably around the BB area – appear to offer value.

US property market

Another area we have looked to for consistent income and capital stability in the portfolio is real estate debt. This asset class is linked to the US property market.

The US property market is an area we like, as the US economy recovers and price rises gather momentum. With this in mind, we like specific commercial and residential mortgage-backed securities, which have both a healthy yield and an attractive risk profile.

We believe this class of debt has relatively limited downside and provides an attractive and diversifying source of income. In addition, these securities are not linked to the corporate profit cycle so we don’t expect them to wobble if corporate earnings come under pressure.

*Barclays High Yield Oil Field Services Index 01/01/14 – 31/01/15, CCC bonds fell by at least 23% (USD).

‘We have cut equity exposure and increased our weighting in higher quality credit’