The key to investing for the rest of 2022 and beyond is to build portfolios that can withstand various scenarios in a low-growth environment.
This is the recommendation of wealth managers as they seek to guide clients through varying stages of stagflation, reflation, soft landing, or slump.
In the short term, unusually high levels of inflation, slowing economic growth, rising interest rates, uncertain monetary policy from the US Federal Reserve, and the fallout from Russia’s war on Ukraine will continue to plague the markets.
Saira Malik, Nuveen’s chief investment officer, says: “The first half of the year was painful. Nearly all asset classes suffered losses, and there were few places to hide. The bad news is the headwinds that drove markets lower are still in place. The good news is we see some potentially better times ahead, including more moderate inflation and (perhaps) less aggressive pace of monetary tightening. Overall, conditions will remain unsettled, but we’re cautiously optimistic that investors will begin to experience less pain and more gain.”
In the long term, there are indications that double-digit opportunities are achievable across emerging markets and other high-risk assets in the alternatives spectrum.
“Beyond commodities, we see value in gold, infrastructure, real estate and private equity which will require plotting a new course for investors in terms of asset allocation,” says Luca Paolini, chief strategist at Pictet Asset Management. “The next five years will present a shake-up to existing approaches to asset allocation as developed-market growth stalls.”
In general, these assessments were shared by participants in a recent Outlook Forum of the BlackRock Investment Institute. They stressed the need to make quicker portfolio shifts amid shrinking investment horizons, and prioritize liquidity.
The participants also questioned the classic portfolio construction set-up of 60% stocks and 40% bonds and are of the consensus that a 40-30-30 split – comprising traditional fixed income, public equities and private assets – is perhaps more apt in the new regime. “Simply betting on mean reversion, or buying the dip won’t work anymore, many agreed,” according to a BlackRock commentary dated June 27.
“Growth concerns, inflation and volatility fuelled the debate at our Outlook Forum over why we’re entering a new macro and market regime and what that means. Poor activity data reinforced slowdown fears, resulting in falling yields and rising stocks last week. Persistent UK inflation caused worries of overtightening,” says Jean Boivin, head of the BlackRock Investment Institute.
Wealth managers are now focusing on building more flexible and creative asset allocation to help their clients build portfolios that can withstand the current highly uncertain and volatile market environment.
In its CIO Outlook for H2 2022 published June 23, UBS makes the following recommendations with the goal of building robust portfolios that can help protect and grow wealth under a wide range of scenarios:
First, to manage portfolio risks in the event of the “stagflation” narrative continuing to drive markets, investors should build and manage a liquidity portfolio, sized to meet three to five years of cashflow needs. “This will likely consist of a mix of cash, cash alternatives, and short-duration bonds. Investors should also consider an adequate allocation to hedge funds, which have the potential to deliver performance even if both bonds and equities are falling,” says UBS.
Second, to build up defences against a potential “slump”, in which lower corporate profit expectations drive weakness in stocks, investors should add exposure to quality-income stocks, the healthcare sector, resilient credit, and the Swiss franc. “Capital-protected strategies may also allow investors to use volatility to work in their favour and mitigate potential downside risks,” according to the Swiss bank.
Third, invest in value, including energy stocks and UK equities. “We think value would perform particularly well in our ‘soft landing’ scenario as increased confidence that corporate earnings can stay resilient benefits some of value’s cyclical sectors, such as financials and energy,” says UBS.
“Inflation above 3% also supports the style. We also like stocks linked to the ‘era of security’. As governments and businesses aim to bolster energy, data, and food security, we think this will spur demand for carbon-zero, cybersecurity, and agricultural-yield solutions.”
Fourth, consider using the sell-off to build longer-term positions. “A quicker-than-expected alleviation of market concerns about inflation could trigger a rally in certain growth stocks, even if this remains a low-probability scenario at this stage. Meanwhile, investing in private equity following public market declines has historically been associated with strong returns,” UBS says.