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As fiscal stimulus starts to fade in the US and Europe, we see increased risks to growth. Investors should look to moderate their risk exposures.
After a decade of economic expansion, long-term analysis suggests we are reaching a point where US growth – and by derivation global growth – starts to plateau, before declining.
Both the US and Europe are withdrawing accommodative monetary policies that have propped up their financial markets since the 2008 financial crisis. The question for investors is what to expect next?
Economic data is still holding up reasonably well. US employment growth is healthy and oil prices relatively subdued – boosting real incomes and brightening the outlook for consumers.
However, it is chiefly because of loose fiscal policy that the US has led developed market expansion. As this stimulus fades through 2019, we can expect growth to slow.
As such, the US Federal Reserve faces a challenging balancing act, mindful of making a policy mistake that could bring the curtain down on this prolonged expansion cycle.
Despite a bounce in equity markets this year, we see increased risks to growth. The Eurozone engine is spluttering, with Brexit at a crunch stage. While China is adding targeted fiscal and monetary stimuli, that’s in the context of an economy transitioning to slower growth.
Add in the prospect that geopolitical instability, trade protectionism and populist politics could further disrupt markets in 2019, and we foresee considerable potential for financial market weakness.
It’s why we think investors should look to moderate their risk exposures. They can no longer rely on traditional equity and bond markets to deliver the kind of returns they have in the past.
Most developed markets are suffering from weakening demographics, heavy debt burdens and rising protectionism. Stocks appear overpriced relative to their earnings prospects, while developed market bond yields remain low and offer scant protection in the event that inflation picks up and triggers an acceleration in rate hikes.
Diversification is a good way to moderate risks without necessarily sacrificing returns. Multi-asset funds allow investors to diversify while keeping things in a single portfolio.
Many funds claim to be diversified. But look closely and you’ll find most offer only a basic mix of equities, bonds and cash. That risks leaving investors exposed in a world where expected equity and bond returns are lower and perhaps more closely correlated.
We believe the best starting point is genuine diversification. The real value of multi-asset investing is being able to combine a range of asset classes with attractive return prospects but different return drivers in order to achieve consistent returns and reduce downside risk.
Of course, identifying which assets offer good long-term potential at acceptable levels of risk takes experience, good judgment and extensive resources.
We recommend that investors choose a manager able to make broader use of asset classes to meet their investment goals and withstand external shocks. In our view this means investing across developed and emerging markets, traditional and higher yielding fixed income and a range of alternative investments.
Among larger, liquid asset classes we favour emerging market local currency bonds on account of the relatively high nominal and real yields on offer. Currency valuations are inexpensive and underlying fundamentals sound – given the healthy medium-term growth prospects of emerging economies.
This asset class has the potential to perform independently of equities, as it did in the equity market falls of 2008 and 2018.
We would also point to the potential of alternative assets with limited correlation to the economic cycle. What drives their revenues is different to what drives traditional equities and bonds, enabling them to provide a recurring income stream that should remain largely unaffected by market turbulence.
Historically such alternative assets have been illiquid, meaning they can be difficult to buy and sell at short notice. However, over the past decade they have become more readily available through listed investment companies that are tradeable on exchange.
These are public companies run by a board of directors who are answerable to the shareholders. The company issues shares and invests the proceeds in alternative assets which they hold in a fund.
This gives the trusts a semi-permanent capital structure that enables them to allocate to alternatives that would otherwise be inaccessible in a regulated vehicle. Such investment companies have opened up a new universe of opportunities for non-professional investors wanting genuine diversification without illiquidity. This includes asset classes such as renewable infrastructure, social infrastructure, property, aircraft leasing, litigation finance and healthcare royalties.
So we would advise investors to diversify their investments to make their portfolios more able to ride out volatility. That, after all, is something we expect to see more of as we look ahead.