After a challenging year for all asset classes, the multi-asset team revisit their predictions for 2022 and describe how their pragmatic approach sets them apart.
The prior decade of loose monetary policy had encouraged cheap borrowing and pushed valuations of some sectors in the global economy to high levels. We explained how ‘growth’ companies had benefitted handsomely over this period, outperforming their ‘value’ equivalents. Crucially, we noted that this trend was set for a significant reversal, and indeed 2022 has played out that way for equity markets. Managers who dogmatically stuck with their equity growth style have seen performance suffer materially.
We believe this inflexibility happens because behavioural biases (irrational beliefs or behaviours that can unconsciously influence decision-making process) creep into investor behaviour over time. A decade of low rates and quantitative easing encouraged some to believe that growth as an equity style was the ‘only game in town’ and updated their investment philosophies accordingly. Unfortunately for them, but unsurprising to us, the unwinding of the performance gap between growth and value equity styles has been both sharp and dramatic.
Source: Jeff Weniger, Head of Equities, Wisdom Tree, using Refinitiv data as of 05/12/22
As we look ahead to 2023, we believe our philosophy of being balanced but nimble remains key to unlocking performance. This philosophy underpins one of our principal views for the forthcoming year; strategies that worked well in the previous era of lower rates are unlikely to be the early winners in the new world of higher interest rates. Betting the house so swiftly on growth outperforming again feels aggressive. As we noted in our previous article, evidence from previous cycles indicates that the outperformance of value has further to run (see graph above). Being pragmatic in our investment approach limits behavioural biases and allows best ideas to continually filter through.
The importance of bonds
Being considered in thought process and implementation reflects our approach in managing multi-asset portfolios. Take the example of fixed income, long derided by investors as ‘return-free risk’ in an environment of low yields. 2022 was the one year in 20 when returns were deeply negative. From sovereigns to corporate bonds, there has been nowhere to hide.
Source: Bloomberg Finance L.P. Copyright Bloomberg Finance L.P. Used with permission.
This has allowed some multi-asset funds to declare victory, almost a decade after they incorrectly declared the death of the bond market. Yet bonds have been closely correlated with equities and the returns on global equity markets in 2022 have been as negative as they have been in global government bonds. Being balanced generates better risk-adjusted returns, made more evident when the herd has been charging in the same direction for years.
We believe that risk-targeted multi-asset portfolios need exposure to bonds to construct optimal portfolios. Our approach blends several risk factors within global bond markets, including currency, region, spread, credit rating and default risk. This allows portfolios to be appropriately tilted wherever we are in the cycle; this factor alone can improve drawdown risk. Those that throw the bond baby out with the bathwater are losing a valuable tool in portfolio construction, negatively impacting the ability to deliver robust risk-adjusted performance. The yield available on bonds is far more attractive today, and through a considered portfolio construction approach we believe they will generate upside opportunity with strong downside protection characteristics in 2023.
Last year’s article ended with an important message – that this was a year where discerning investors would be rewarded for being disciplined. We believe the performance of our risk-profiled multi-asset funds over the last year reflects this disciplined approach. 2023 will also prove challenging, as a global economy that may well tip into recession requires agility and balance from experienced fund managers. We optimise our portfolios daily, with no need to wait for monthly or quarterly rebalancing points. As important, we work tirelessly to remain unencumbered by behavioural biases – we don’t permanently love particular asset classes and hate others. We judge every holding, across all asset classes, on its own merit. As the financial market landscape continues to evolve in an era of structurally higher interest rates, our pragmatism remains our edge.
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