- Co-Head of Multi-Asset Platform
Asia ex-Japan, Institutional
Change
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Key points
- Three dynamic forces — the “3Ds” of divergence, dispersion and disruption — are shaping today’s investment landscape and will continue to play out in the second half of this year.
- Amid increasing divergence, credit investing approaches focused on seeking consistent, diversified income can help to stabilise returns as cycles become shorter and more volatile.
- To exploit growing dispersion, a total return approach invested in high-quality credit across different sectors and regions can complement a more income-focused approach.
- Within equities, an active, research-based approach can help to uncover those quality companies that are positioned for success in a world of growing technological disruption.
The new reality we find ourselves in — featuring higher market volatility, more frequent and shorter economic cycles, and higher and more persistent inflation — is not only markedly different from the one investors experienced a decade ago, but also from the environment they faced less than six months ago. How should investors reassessing their allocations to cash, equity and fixed income respond?
Above all, in today’s more volatile environment, investors need flexibility and diversification in their asset allocations to adapt to changing market conditions and exploit dislocations as they arise, rather than simply defaulting to what has worked before. In my view, assessing the world through a “3D” lens — focused on divergence, dispersion and disruption — can help to unlock the investment opportunities these dynamic forces are creating:
- Divergence opportunities are stemming from global economies increasingly being at different phases of the business cycle and implementing varied monetary and fiscal policy regimes.
- Dispersion opportunities are emerging as a less homogeneous macro and market environment is leading to greater differences in company results.
- Disruption opportunities are arising as technological innovations, notably AI but also biotech and fintech, are shifting the landscape of winners and losers.
A 3D approach to asset allocation
Divergence, dispersion and disruption have significant implications across the asset allocation spectrum. Here, I outline three areas where I believe the 3Ds present compelling opportunities for active fixed income and equity investors.
Divergence: focus on consistent, diversified income
A more divergent world increases the potential benefits of taking a flexible and dynamic active approach to exploit the opportunities created by increased divergence and volatility across asset classes, regions and sectors. In this environment, where the path to returns may be rockier than it has been in the past, income’s potential to not only generate consistent income streams but also act as a driver of returns makes it an important component in today’s investment portfolios.
In fixed income, for example, credit investing approaches that seek to achieve consistent, diversified income can help to stabilise returns as cycles become shorter and more volatile, and accessing the full range of global credit sectors can help to provide income across different market environments.
High-quality fixed income has typically played a valuable role in diversifying investors’ portfolios, and current bond yields in most developed markets offer an opportunity for investors to move out of cash. This is an important consideration as staying in cash carries with it both reinvestment risk and duration risk. Reinvestment risk means if short-term interest rates drop quickly, cash investors are forced to reinvest at lower, less attractive rates. And duration risk is the risk that cash investors assume by keeping their investments in short-duration bonds. Falling interest rates typically lead to capital appreciation in longer-duration bonds, which cash investors would miss out on.
Dispersion: focus on quality and total return
Many companies are facing much higher costs of capital than they have for some time and, amid a still uncertain macro outlook, are generally confronting a more volatile environment. The greater dispersion this backdrop is creating in the performance of companies — particularly in sectors undergoing rapid transformation like energy and financials — means that quality is becoming an increasingly important feature in portfolios.
In fixed income, investing in higher-quality credit has potential appeal from both an income and capital protection perspective, with the income from these strategies not only attractive outright but also providing an additional buffer to rate volatility.
For investors looking for growth as well as income from their fixed income exposure, a total return approach invested in high-quality issuers across different sectors and regions can complement a more income-focused approach. An allocation to government bonds can provide capital to deploy when volatility creates attractive capital appreciation opportunities. And when credit spreads are tight, holding higher allocations to government bonds can help to protect capital and insulate portfolios from the potential for negative price return to overwhelm income.
Disruption: focus on the beneficiaries of technological change
An active, research-based approach to equity investing can help to uncover which companies are positioned for failure and which are positioned for success in a world of growing technological disruption, most notably by AI.
As companies across sectors and industries increasingly adopt AI — lowering costs and creating new revenue streams in the process — thematic investment opportunities will arise from being on the right side of that innovation and disruption. Technology companies that can demonstrate both quality returns and growth at scale, for example, should stand out as winners. Equally, the transition to digital payments presents some potentially attractive opportunities among financial services and payments companies. Health care service providers and pharmaceutical companies that have strong competitive advantages driven by scale and innovation and are managing unmet medical needs should also be among the key beneficiaries of accelerating technological change.
Time for active management to shine
Given the sheer unpredictability of today’s world, investors may be tempted to adopt a wait-and-see attitude. However, while staying in cash may have been a good approach last year, when most central banks were raising interest rates, now — as yields have likely reached their peaks and central banks are starting to ease — standing on the sidelines may no longer work as well. Instead, an approach that actively focuses on identifying the many opportunities resulting from the new 3D reality may offer a more rewarding path to unlocking investment value and strengthening portfolio resilience.
Monthly Market Review — October 2024
A monthly update on equity, fixed income, currency, and commodity markets.
By
Brett Hinds
Jameson Dunn