With so much uncertainty in global markets, taking a multi-asset approach to investing can be a great way for investors to meet their retirement goals. Nader Naeimi, Head of Dynamic Markets, outlines why this is the case and shares 4 key investment principles to keep in mind.
Equity markets in some parts of the world are skittish right now. In fact, they usually are. Right now, it’s the potential for trade tariffs, Iran negotiations and rising oil prices that have investors in the US worried. Next week it could be something, somewhere else.
Whether it’s the need to invest in a rising interest rate market or be on the winning side of currency fluctuations; taking a multi-asset approach can be a great way for customers to understand their total return potential and invest to meet their retirement goals.
It comes down to managing risk. I think the best way to do this is by combining asset classes that have a low correlation with each other. Investing in assets that are influenced by different return drivers, or which access unique sources of return, can further enhance the degree of diversification in a portfolio.
Taking a multi-asset approach ties in perfectly with dynamic asset allocation, as it means that investment opportunities are not stuck in one sector, country, commodity, or cycle, and can instead be found where ever there is value and the reward at that time outweighs the risk.
Markets do not always behave in ways consistent with the underlying fundamentals, and dynamic asset allocation allows professional investors to make the most of this.
Dynamic asset allocation (DAA) is more nimble than strategic asset allocation (SAA) because it allows us to capture short-term market inefficiencies, rather than SAA, which uses market equilibrium assumptions to set weightings of different asset classes.
The main principle underpinning a DAA approach to investing is that just about everything in financial markets is cyclical. The pendulum-like swings in investor sentiment is one thing that investors can depend on.
Financial success increasingly depends on a better understanding of the market and economic cycles, with the ebb and flow of stock markets presenting enormous opportunities to generate wealth if market cycles are accurately understood.
Market cycles range from multi-year periods called ‘secular’ cycles to multi-month periods called ‘cyclical or business’ cycles. The key to understanding what drives stock market cycles is to recognise that there are concurrent cycles at play during any given time.
While the secular cycle determines the primary trend in the share market, the cyclical or business cycles also have a great capacity to impact investors’ financial goals. Importantly, while secular cycles are driven by valuations, cyclical moves are driven by investor sentiment and central bank actions.
The following principles are engraved within our DAA investment process and we believe are valuable considerations for all investors:
- Risk is not the same as volatility – risk is the potential to lose money and not recover; volatility is a backward-looking measure at how variable an asset is. Therefore, price risk should be a stronger focus than backward-looking analysis.
- Risk and return are different sides of the same coin – there is often more risk in to investing in high performing and crowded companies with low volatility than the apparent low performing and unloved companies with high volatility. This is due to the critical role ‘investor expectation’ plays, where the expectations on high performing companies become increasingly hard to meet. Similarly, expectations on the low performing companies are low and hence become easy to beat.
- Diversification based on historical correlation is destructive – correlations can change; typically increasing during economic instability. Overcrowding and the typical high pricing of popular investments leads to high correlation when the economy turns and investors decide to sell at the same time. Therefore, the diversification benefits that are crucial during these times aren’t received. Smarter diversification can be based on how assets are valued and how crowded the positioning is, rather than relying on historical correlations.
- The market cycle leads the economic cycle – if you aim to buy assets when the economic cycle is strong and sell them when it’s weak, you will inevitably miss out on opportunities and be exposed to risks. History has shown us that weak economic conditions don’t always lead to weak future share market returns. It would be unreasonable to assume that the macroeconomics and earnings impact on future market returns is insignificant. Indeed, a sustained and durable move higher in shares requires strong support from earnings growth and a healthy macro backdrop.
Managing a dynamic asset allocation process requires time, access to professional research, market intelligence, tightly-held research, and most definitely experience. Having the ability to be nimble when the market throws up unique opportunities though, can make it worth the effort.
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