Matthew Bullock of Wellington Management warns against investor complacency and outlines strategies for growth and income designed for uncertain times.
Investors have had a good run. For example, the last five years have seen equities rise by 15% per annum and bonds rise by 6% per annum1 [i], which is significantly above historical norms. However, a lengthy rally can breed complacency, despite history clearly warning that markets don't rise forever.
The VIX [ii] index provides a possible sign of that complacency. The stock market 'fear gauge' has remained below 11 for long periods during the summer of 2017. The last time the VIX registered below 11 was just before the global financial crisis. Investors might therefore be wise to consider what could happen to their portfolios if markets suffered a significant and protracted downturn, which could erode much of the gains accumulated during the current rally.
Asset valuations are close to all-time highs and are defying investment fundamentals. Income is getting harder to find. The geopolitical outlook is increasingly uncertain. How can you best position your portfolio against this backdrop? Next generation multi-asset solutions targeting growth and income provide a good starting point, in our view.
Next generation multi-asset funds aim to provide investors with consistent and sustainable long-term performance across the cycle. This means they should seek to protect capital in falling markets while participating in rising markets. And, through embedded diversification, they should exhibit significantly lower volatility and shallower drawdowns than broad equity markets.
We believe that while no investment can be guaranteed, truly diversified strategies with the right structures should prove capable of meeting these goals. Such strategies are likely to share three characteristics:
- A low correlation to traditional asset classes
- A range of return sources lowly correlated to each other
- Multi-layered risk management
We design portfolios based on these three strategy characteristics to meet both growth and income objectives. Our approach to managing the market volatility risk that investors face is to embed genuine diversification within portfolios.
What outcome are you seeking?
We are in a world of solutions-driven investing and we believe investors should no longer consider asset classes as the starting point of portfolio construction. They should instead focus on the objectives they desire, and the strategies that can best achieve those outcomes. The mix of assets used to get there is the secondary consideration.
Our growth solution, Multi-Asset Absolute Return (MAAR), maintains low correlations between multiple sources of return and overall to markets, which can help support smoother and more consistent returns during periods of volatility. MAAR targets three main drivers of return that have low correlations to each other:
- Alternatives: A range of approaches, including relative value, momentum, equity styles and carry, designed to maintain a very low or negative correlation to markets.
- Manager alpha: Opportunities for active stock selectors to outperform broader markets, while we seek to hedge out any broader market exposure to simply capture the outperformance.
- Market exposures: Dynamic exposure to a diversified portfolio targeting the general tendency of markets to rise over the long term.
Our solution to the challenge of generating income while managing downside risk is a three-part multi-asset strategy we call Dynamic Diversified Income (DDI). This allocates dynamically across a yield-focused portfolio that is diversified not just by traditional and alternative asset classes but also by factors not dependent on market direction. We believe this supports a more robust, 'all-weather' portfolio. We then use the power of compounding (Einstein's "eighth wonder of the world") to target an attractive regular income that is above inflation and sourced from the natural yield of the portfolio. It's critical that the income we generate is sustainable, so we look to set the natural yield higher than the distribution. In this way, and unlike many competitors, we designed our strategy with the aim of not having to access capital to meet our income target.
Matthew Bullock is investment director of multi-asset strategies at Wellington Management
To learn more about how next generation multi-asset strategies could help you meet your growth and income objectives, contact:
020 7126 6086
020 7126 6085