Investors should look to alternatives and diversified real assets, whilst keeping an eye on attractive valuations in equity and fixed income markets, according to two chief investment officers.
High inflation and stretched valuations in both fixed income and equity markets have given investors a turbulent ride in 2022.
This was compounded by Russia’s invasion of Ukraine, triggering an energy crisis and China’s staunch committal to zero-Covid policy, choking supply routes.
With concerns across the board, how can investors create diversified portfolios offering downside, income and inflation protection?
Marta Norton, CIO, Americas at Morningstar said: “With planning and a whole lot of humility we think multi-asset investors can weather this stretch just fine.”
While global equities and core bonds remain enduring components of a multi-asset portfolio, Norton argued that the benchmark approach courts risk.
Performance year-to-date has shown how sensitive both areas have been to rising inflation and rate hikes.
“Commodities don’t produce cash flows”
Commodities act as a traditional inflation hedge and performance has been strong in an environment of structural supply shortages.
Norton argued while commodities have historically hedged inflation when it is high and rising, performance across the asset class varies wildly.
“Unlike equities and fixed income, commodities don’t produce cash flows, making it hard for investors to know whether they are over or underpaying,” she added.
“Our preference is for shares of commodity-related businesses since we’re able to assess the value of those companies.”
But with uncertainty still high and inflation and rate hikes priced in, a broad switch to commodities may be misguided if stocks and bonds rally.
“Here’s our playbook,” she started. “Plan for a range of outcomes and let valuation be a deciding factor. Today, we view high-quality segments of fixed income as reasonably attractive, particularly within the US corporate and agency mortgage-backed bond market.
“Yield levels are more attractive than previously; plus, the bonds don’t have the same interest-rate sensitivity as longer-dated bonds, an important consideration if rates continue to rise.
“Plus, short-term bonds—not to mention cash—are easy to sell if opportunities emerge elsewhere.”
Norton said that within equities, valuations are reasonable across energy, financials, consumer staples and healthcare – each benefitting from different market conditions.
“Financials have a head start if rate increases control inflation but don’t cause a recession, while healthcare seems to have an edge during stagflation,” she said.
“We’re also tilted toward out-of-favor non-US markets: China, European financials, and Germany.”
Don’t lose sight of the importance of fixed income
Todd Jablonski, CIO and head of asset allocation at Principal Global Investors said that he is seeing a great deal of client interest in strategies that allocate to real assets.
Real assets, of course, include commodities but infrastructure, real estate and natural resources too – adding to the inflation resistance in a portfolio.
However, Jablonski was clear that investors should not lose sight of the importance of fixed income.
“Yes, this is the worst year on record for bonds to-date, but the market stands in a more attractive position today than it did at the beginning of the year,” he said.
He added that there is opportunity to mitigate risk with fixed income based on the expectation that rate volatility should diminish over the next year to offer a respectable income return.
“So, appreciate the asset class for what it is – an anchor in your portfolio that should not be overly or unduly unfinished in investors’ portfolios.”
