The last decade produced great performance across most asset classes. But in the 2020s, we expect investment market returns will be lower and risk harder to manage. Looking forward, a disciplined multi-asset approach will be especially valuable to identify opportunities and help mitigate setbacks.
Powerful returns in 2019 meant that strategic allocation didn’t matter all that much for investors. Equities led the way by notching a new high, but performance was strong across asset classes and categories, from stocks to bonds to real estate and other diversifiers. This trend has persisted for most of the last 10 years.
But the good times may be coming to an end. We believe markets will face profound changes in the decade ahead. Secular challenges include adverse demographics in developed economies and in China, slow productivity growth and the drag on both consumption and investment from servicing unprecedent amounts of debt. Cyclical headwinds feature high asset valuations (after a decade of easy monetary policy and credit-driven expansion), populist pressures and rising geopolitical risks.
While this does not mean a protracted sell-off is around the corner, we expect lower market returns across most asset classes over the next 10 years (Display). Meanwhile, downside risks will proliferate and heighten as policymakers struggle to find effective responses to these intractable problems.
With a multi-asset approach, investors can navigate this trickier terrain using a wide range of tools to build a portfolio, from traditional asset classes to beta diversifiers, alternatives, timing strategies and options. Multi-asset strategies can also help income investors rethink how to generate income while managing risks. Focusing on the year ahead, we advocate five strategies to face up to the changing environment:
1. Be Warier in Equities—Consider Europe and Emerging Markets
Global earnings growth is weakening. In 2020, we expect earnings-growth estimates will fall into the low to mid-single digits. And much of the meager earnings gains will likely be driven by buybacks and corporate financing activities—not sales growth. Corporate profit margins appear to have peaked, particularly in the US, amid rising unit labor costs that may force companies to be more cautious on hiring and spending. In Europe, equity valuations are more attractive, and a weak euro should support the eurozone’s many export-oriented companies. Upward earnings revisions and an improving corporate outlook also favor selective exposure to emerging-market stocks including China A-shares.
2. Resist the Urge to Ditch Duration
Interest-rate exposure was once seen as the cornerstone of downside mitigation. However, very low and negative government bond yields around the world have raised questions about how much protection duration can provide in a risk-off scenario. Still, the uncertain outlook for growth and risk-asset returns justifies a risk-management approach that offsets some equity exposure with interest-rate exposure. Even in Europe, where yields are low, duration can help, in part because the curve is steeper than that in the US, providing greater return potential.
3. Consider Select Alternative Strategies
Select alternative strategies offer beta diversification and attractive risk/return characteristics. For instance, liquid alternative strategies have struggled in recent years but may be set to come into their own. With the 2020 market outlook uncertain at best, investors willing to pursue volatility-harvesting strategies that sell protection against rising risk may earn attractive premiums and potentially boost overall returns. It might also be worth considering merger arbitrage strategies. Companies are struggling to find organic growth opportunities, and low borrowing costs may enhance the appeal of strategic acquisitions to boost growth.
4. Unfollow the Trend
Growth and geopolitical risks could make it difficult for markets to establish lasting trends. So investors should avoid putting too much weight on trend-following signals, such as volatility or momentum, and should reassess their risk-management strategies frequently. In our view, a muddle-through period with risk-on/risk-off swings is the most likely road ahead. In those conditions, it makes sense to put more emphasis on signals that capture underlying market fundamentals. These include valuations, corporate balance-sheet quality, stimulus and inflation.
5. Broaden Your Income Horizons
Generating income when more than US$12 trillion of high-grade debt carries negative yields will be a major challenge, too. To avoid taking excessive risk, we think investors should widen their horizons. Within fixed income, that means taking a global, multi-sector approach. For example, an allocation to US high-yield bonds is a useful income diversifier with solid fundamentals, in our view. But it also means looking beyond bonds and embracing a multi-asset strategy that can uncover opportunities in real-estate investment trusts (REITs), master limited partnerships (MLPs), securitized assets and even global equities.
Applying these five principles in a disciplined multi-asset strategy is a good way to usher in the new decade. Drawing on diverse parts of the capital markets can help investors capture resilient return drivers while reducing the risks of the new and tougher challenges that the 2020s are likely to bring.
- Daniel Loewy
- Chief Investment Officer and Head—Multi-Asset Solutions
- Karen Watkin
- Portfolio Manager—Multi-Asset Solutions