Global financial markets have experienced a great deal of volatility over the past 12 months as investors have become concerned about a number of headwinds.
It is interesting to observe how quickly attention switches from one topic to the next, but most of the issues concerning investors in the past year or so – slowing growth in China, the prospect of US interest rate rises, political events such as Brexit, and the forthcoming US election – have not really gone away.
Any one of these could re-emerge in the future, or it could be something else entirely.
This uncertainty is a permanent feature of the investment space, and as such it is important to construct portfolios with the flexibility to respond quickly and meaningfully to whatever lies ahead.
Whatever the investment philosophy or process, asset allocation essentially boils down to considering all investment decisions as part of the whole. How does each investment fit with the rest of the portfolio?
What outcomes do you want to achieve, and over what period? How much risk is the portfolio exposed to?
The conventional approach to making these decisions is to start by looking at assets in terms of a sense of the differing levels of risk-return trade-off typically offered by different asset classes.
Many of these assessments of ‘riskiness’ are perfectly logical in theory – investors would probably be more confident in the ability of the US government to pay them back than a company with a low credit rating, for example.
Therefore, US Treasuries would be expected to sit lower on the risk-return spectrum than high-yield corporate bonds. But at certain periods investors have lost more money on US treasuries than they have on high-yield corporate bonds – it depends on the prevailing market environment at any one time.
| Expert View: Making sense of volatility |
Meike Bliebenicht, senior product specialist for multi-asset at HSBC Global Asset Management, says: “So far this year we have seen phases of episodic volatility in markets. More often than not volatility is the consequence of an excessively sensitive reaction to adverse news flow. Markets are made up of people and are therefore prone to overreacting or misinterpreting information. “Making sense of the market environment therefore requires a clear, structured and disciplined analysis of economic risks. It also requires broad asset diversification – holding those government bonds for when riskier assets decline sharply – and ensuring a broad opportunity set to capture the returns of less conventional assets. “Looking ahead, an environment of low economic growth, low inflation and low developed market interest rates will persist, with important implications for asset markets. “Specifically, medium-term returns are likely to be low relative to recent history across the major asset classes, and particularly poor for developed market government bonds. Yet the broad environment remains supportive for equities, at least relative to government bonds, and there is still value in high-yield corporate bonds and local currency emerging market debt. “Being active in asset allocation and being well diversified will continue to be very important.” |
