HUB EXCLUSIVES PANEL DISCUSSION 2023 – THE TOOLKIT NEEDED FOR THE NEW MARKET ENVIRONMENT
Panel discussion, hosted by Cherry Reynard, with:
Daniel Hughes, Premier Miton Defensive Growth Fund Manager, Premier Miton Investors
Olivia Geldenhuys, Investment Director, Schroders
Mark Lane, Senior Investment Manager for MyFolio Sustainable Funds, abrdn
2022 brutally exposed the limitations of a traditional diversification approach, as both bond and equity markets dropped simultaneously. But with bond yields higher and equity markets showing greater stability, is it back to ‘business as usual’ for multi-asset managers? Or is a more nuanced approach required to manage through the current environment?
Olivia Geldenhuys, investment director at Schroders, points out that there is a lot for investors to digest, over and above higher interest rates. She says: “We are going through a regime shift. Inflation is likely to remain elevated. There are demographic changes, a tight labour market, deglobalisation, plus shifting supply chains. Investors also need to take account of the effect of decarbonisation as the world moves to a cleaner, greener environment.”
However, she does not believe that this should prompt a wholesale re-evaluation of how multi-asset managers approach diversification. She points out that this is not the first time bonds and equities have fallen in tandem and investors should not have been relying solely on the two asset classes to provide portfolio balance.
Daniel Hughes, manager on the Premier Miton Diversified funds, agrees: “We’ve always had quite a different approach to diversification from the usual 60/40 portfolio. We use a hedging strategy where we mitigate the impact of market risk on portfolio. We find this a more efficient way to mitigate risk than relying on historical correlations to be there when you need them. In 2022, bonds did a poor job of diversifying equity risk and even gold didn’t perform as some had hoped.
“Using this overlay, allows our equity managers to find the companies they have conviction in and stick with them. We can then use the targeted hedging strategy to reduce the portfolio’s sensitivity to the macroeconomic environment at times when there’s more stress around the markets.”
Diversification is still important, says Geldenhuys, but it can’t just be an allocation to a range of different asset classes, it is also about not investing a portfolio in a specific way based on a single set of beliefs. This has been one of the most important lessons of the past decade, she adds.
Alternatives
The past few years have seen many multi-asset managers adopt alternatives to replace low-yielding bonds in their portfolios. Even though fixed income now appears to offer a high yielding, diversifying alternative to stock market investments, many are sticking selectively with alternatives.
Mark Lane, senior investment manager for MyFolio Sustainable Funds, abrdn, says the group’s alternatives allocation is usually funded from defensive assets, so there is a higher bar now that government bonds are paying a higher yield. He also sees risks in some alternatives, notably private equity strategies: “We are more cautious about those areas, particularly where liquidity may be an issue. It is vital to isolate the different types of alternatives and understand the role they’re serving in a portfolio.”
Derivatives also have a role in promoting portfolio stability, says Hughes: “Using derivatives is an efficient way to manage and control the impact of market risk on portfolios. It means our managers can focus on taking risk where they want to take risk."
That said, Premier Miton doesn’t just use derivatives for risk mitigation, but also to get exposure to strategies that it doesn’t have exposure to elsewhere. “We don’t want to go to individual managers and say buy more cyclical value stocks. We would rather use a derivative that can give us that tilt. This can sit alongside the equity portfolio and we can leave fund managers to do what they do best.”
The impact of ESG
Incorporating ESG considerations into a portfolio is now a necessity, says Geldenhuys. However, she says the Schroders multi-asset team is careful to balance ESG and diversification considerations: “In some areas of the market, it is difficult to get high quality ESG investments. It is important to recognise that if certain asset classes are excluded, it can affect diversification and may bring more volatility.”
She says that areas such as alternatives and government bonds can still be difficult to assess from a sustainability point of view. Investors need to recognise that the equity market is currently ahead of other areas on ESG integration and there is a balance to be struck.
Multi-asset managers are not going back to the 60/40 approach just because fixed income has returned to normal, but are instead sticking with the nuanced approach to diversification that has supported them through much of the past decade.
