Does the new regime require a different approach to asset allocation?

  • Christopher Ellis Thomas

Is the traditional portfolio model broken? It’s a question many are asking after the events of 2022, when the inverse correlation between stocks and bonds broke down. This left some of those with the lowest risk appetites nursing the biggest losses1.

The relationship between bonds and equities may have returned to something close to historic normality in recent months. But the extent to which you can rely on that inverse relationship holding, especially the longer an equity sell-off lasts, is lower. And investment experts are still working against a backdrop of global volatility and inflation caused by geopolitical tension, the transition to a low-carbon economy and changing demographics across the globe. The Great Moderation, a 40-year period of largely stable activity and inflation, has come to an end.

When building portfolios on shifting sands, investment managers need the very best tools available. Top of the list is the ability to move their asset allocations as the economic backdrop changes, allowing them to take advantage of the opportunities created in times of volatility.

The ability to pursue a more granular and dynamic approach to allocating funds, alongside benefitting from low charges, will ultimately prove key to investors going forward.

In a world that moves quickly, can anyone afford to let their asset-allocation model stand still?

The breakdown of the traditional model

2022 was the year that broke the mould. The 20-year experience of returns from bonds and equities being negatively correlated was challenged by a 12-month period in which both assets fell significantly.

This resulted in poorer performance from funds intended to serve the needs of more cautious investors – those which contain a higher ratio of bonds to equities in an effort to provide stability.

It is important to understand why this happened, to see whether investment styles need to change or whether we need to write off 2022 as an anomaly and carry on with traditional, static asset allocation as normal.

A breakdown in this negative correlation has happened before. The 1970s, 80s and 90s in fact saw several periods when the relationship between equities and bonds broke down. The backdrop to this might look familiar: heightened inflation and interest rate volatility.

However, it is unusual for equities and bonds to fall together – that has happened only a handful of times since the 1940s. But, if inflation continues to surprise, it may happen again.

How BlackRock MyMap responded in 2022

The ability to tilt the equity/bond weighting is key to dealing with periods in which uncertainty reigns. Where static allocation funds are unable to do this, managers in multi-asset funds such as BlackRock MyMap can alter the ratio of their assets to suit changing times.

Going into 2022, BlackRock MyMap portfolio managers saw risks around rising interest rates, which made a weighting in bonds look less reliable as a way to diversify a portfolio, particularly for those with low-risk tolerance. In response, managers kept a lower duration within their fixed-income investments, keeping the exposure to more interest-rate-sensitive bonds low.

We sought dynamic solutions, adding positions in Japan and other Pacific equities whilst diversifying within fixed income by holding more investment-grade corporate bonds in different territories.

Managers also thought beyond equities and bonds, investing in satellite assets such as gold and commodities to establish a different type of diversification.

When inflation intensified, our lowest-risk investments weren’t stuck in a downward spiral. Although some of our higher-risk funds have underperformed those of our peers in 2022, we believe that our exposure to international equities, rather than concentrating on the UK, will prove to be beneficial in the long run.

An uncertain outlook

Negative correlation is back, for now, but how reliable is it? The global environment suggests more turbulent times ahead.

Inflation is likely to fall from its current elevated levels but is forecast to stay above central banks’ 2% limit for some time. In the longer term, changes in the macro environment look set to continue the inflationary trend.

Chief among those is geopolitical risk, leading to geopolitical fragmentation and the rewiring of supply chains. Shrinking workforces as a result of ageing populations will constrain production, prompting higher prices. Then there are the as yet unknown consequences of the transition to a low-carbon economy, which will involve a huge reallocation of resources. These “mega forces” will drive returns over the long term, but could also constrain production and add to inflation – as described in the BlackRock Investment Institute’s Midyear Outlook.

In these changing times, the old rules cannot be relied on. There are abundant opportunities in this new and more volatile regime for those who are willing to take a more granular approach, and to act nimbly to take advantage of widening discrepancies in asset values.

Funds for the future

The environment is increasingly uncertain, but investors are asking for more certainty than ever. Risk-rated funds such as BlackRock MyMap must use all the tools at their disposal if they are to meet customer objectives.

It is important that we learn lessons from 2022, when the most risk-averse investors were the ones to suffer most from an unexpected change in the behaviour of equities versus bonds.

Remaining agile is the best way to ensure customers are not exposed to undue risk. Using risk targeting, rather than static models, ensures assets can be allocated dynamically to manage a difficult situation.

Rather than concern themselves with percentages of different assets, managers need to focus on the risk they are taking, with no asset held naively and every investment there for a reason. That way they can find opportunities as well as lessen risk for investors.

Recent years have also underlined the importance of currency exposure to overall returns. In an era of geopolitical fragmentation, customers need to be able to trust that there is enough scrutiny in this regard.

Currency risk varies over time and can be a large proportion of overall risk. This is something that should be actively monitored and, when appropriate, hedged.

Controlling costs is also vital for long-term performance, and there’s a balance to strike between keeping costs down, yet being agile enough to ensure performance.

All MyMap funds charge a 0.17% fee except for the BlackRock MyMap 4 Select Income, which charges 0.28%*. This compares favourably with static allocation funds and gives investors the benefit of a more active approach.

As the past few years have shown, it’s increasingly hard to predict the future. When the only thing we can be certain of is uncertainty, we know that finding the right outcome for investors takes speed and agility. For those in search of a solution, dynamic allocation may be part of the answer. BlackRock’s MyMap funds are low-cost funds that are simple to invest in – they may be the vehicle to navigate the uncertainty ahead.

Interested in learning more about BlackRock’s MyMap fund range?

Visit the MyMap website. Alternatively, drop us an email or connect with a sales representative on our dedicated MyMap hotline +44 207 743 1450.

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*Figures shown are for the D Share class

1 MoneyWeek, “ Low-risk portfolio investors suffer highest losses”, Low-risk portfolio investors suffer highest losses | MoneyWeek (Accessed: 20 July 2023)

Christopher Ellis Thomas
MyMap Co-Portfolio Manager, BlackRock