Multi-asset investors expect lower returns across all asset classes and venture into more complex or niche strategies to hedge against losses and find gains.
Government bond yields remain close to their historic lows and some markets, such as Germany, remain in negative territory. Corporate bond spreads across the credit spectrum are at record highs and index-level stock valuations appear stretched.
A strong period for equities was justified by strong corporate earnings, but heading into 2022 Lionel Schwerer, fund of fund manager at Generali Investment Partners, said companies would be strangled by rising prices raw material.
“The results of the companies have been very good,” he said. “They were able to show flexibility in managing the Covid crisis and obtained good results. That said, we will see a squeeze in margins next year with the impact of commodity prices.
“While in 2021 companies were still covered against some of these increases due to previous hedges or negotiations, in 2022 that will no longer be the case. So I wouldn’t expect too much of an increase in the stock indexes. ‘
Davide Saccone, head of investment manager oversight in Quaestio Capital’s multi-asset team, agrees that next year’s returns are likely to be lower.
He expects more uncertainty and volatility with increased dispersion between sectors and regions. “The important point of having a multi-asset strategy or a multi-asset fund is being able to tap into those premiums that you can find from time to time in different industries and regions,” he said.
Luca Dal Mas, multi-manager team leader within the multi-asset and macro team of Aviva Investors, also makes a distinction between and within indices.
Interest rate sensitive sectors, such as financials and consumer stocks, and commodity-related sectors like energy, have long been depressed.
“There is still room for appreciation,” he said. “But at the asset class level, it is reasonable to expect a correction in valuation.”
A market correction is a short-term issue for multi-asset managers. In the medium to long term, the big problem for Dal Mas is the correlation, mainly between interest rates and stocks, which “opens up a completely different scenario for multi-asset portfolios and how to build the portfolio”.
Other key risks identified around the table were monetary policy errors and contagion from countries like China. “We have seen recently what has happened with the overheating of real estate and that it could have an impact even on us and our financial systems,” said Schwerer.
There was consensus that the key to long-term success is not how a fund performs in bull markets, but how it protects itself in bear markets.
“If you manage good downside defense you can rack up upside returns faster,” said Dal Mas. “In addition, psychologically, it is less of a success for any client, whether retail or institutional. It’s the job of a multi-asset portfolio manager to try to limit that for clients and let them sleep at night. ‘
To minimize drawdown and reduce volatility, the “first golden rule” for Davide Cataldo, Head of Absolute Return Multi-Strategy at Amundi Asset Management, is diversification, followed by stop-loss rules and hedging.
“You insist on the wallet to try to limit the negative impact of the black swan events,” he said. “You closely monitor the correlation within your portfolio and how your portfolio reacts to market indices.
“On top of that, you still want to have a very complex portfolio covering various risks. Hedging can be correlated but, in particular for us, the use of options is a way to reduce tail risk. ‘
Saccone agrees with Cataldo that in an environment of lower returns and higher volatility, unconstrained absolute return strategies make perfect sense.
“It will be a tough environment for investors, but it might be a good time to add or increase exposure to absolute return strategies,” Cataldo said.
“As an absolute return manager, I think this type of product should always be in a portfolio because if it keeps its promises, that is to say a lower correlation with the markets, the addition of such a fund or portfolio to your asset allocation increases the efficiency of your portfolio. ‘
In addition to defending the cons, Aviva’s Dal Mas stressed the importance of having the flexibility to generate alpha.
“There are alternative strategies that fail on this point, like absolute return bond funds, which have been sold to clients for some time,” he said. “While they didn’t lose too much money, they didn’t achieve the returns we expected as allocators.”
Cataldo of Amundi said he uses absolute return strategies to seek alternative sources of earnings.
“The use of strict risk management rules stabilizes the portfolio and gives us a lot of powder to deploy to seize opportunities when they are offered to us for investment,” he said. “Diversification is more difficult to achieve than in the past, so we have to find alternative sources of alpha.
“Directionality is not the only way to achieve our performance objective. We need to be more aggressive in adjusting not only asset allocation but also opening and closing relative value strategies. We have this ability to reverse the position and be very aggressive in adjusting the portfolio to market conditions. ‘
Managers with the right knowledge and resources can extract returns from volatile markets. “It’s a source that has been used less in the past and could become more relevant,” said Dal Mas.
He questions whether income-producing assets – high yield, investment grade and structured credit – will be used more widely by multi-asset managers as a means of smoothing returns.
Generali saw plenty of opportunity in another income-producing asset this year – merger-acquisition arbitrage. “There have been a record number of merger arbitrage situations with companies seeking to adapt to this new environment,” said Schwerer. “As you diversify, you get new returns. “