Newton Investment Management’s CEO, Euan Munro, explains why he believes it is now critical to challenge the norms of multi-asset investing.
Well-constructed multi-asset funds should recognise that we know very little about the future. After all, over the last decade, our economic pathway and consequent market-return outcomes might have been radically different if alternative choices had been made on key issues like the speed of intergovernmental response to climate change, or the reaction of governments and central banks to the Covid-19 pandemic. There have also been some knife-edge but consequential political choices, such as who would be US president, or whether the UK would stay in the European Union or not. Financial-market outcomes could have been very different if these choices had gone differently.
Great multi-asset design needs to be robust enough to accommodate as many possible futures as practicable because, unless you have a valid claim to omniscience, it is irresponsible to build a portfolio that only works on one pathway.
Many approaches to portfolio construction assume that the only sensible method is to use historic returns and volatilities of asset classes, as well as the correlations between asset classes, to help build a robust and well-diversified portfolio for the future. However, this implicitly assumes that the future will, in many important respects, look exactly like the past – and so, in fact, those that apply such an approach are making (or at least implying) quite a detailed forecast of future market conditions, whether they realise it or not.
In economics, just as in physics, it is reasonable to assume that a system will continue behaving as it did before, provided that you are not close to any critical boundary conditions. However, when boundaries are reached, this can lead to the common (but also foreseeable) error of overfitting models of the future by using historic data.
At Newton, we think we are approaching some important boundaries, including in relation to climate change and its impact on economic growth, China’s economic rebalancing, and the scale of sovereign debt and central banks’ balance sheets. We believe these factors could have significant implications for market returns, volatility, and the correlation between asset classes.
A flexible approach to diversification
In this context, we would suggest that, instead of artificially constraining portfolios to have a fixed equity/bond structure, clients may be better served by unconstrained multi-asset strategies where the only constraint is the absolute level of risk, and this can be set at the same level as (or a higher or lower level than) a classical balanced fund.
These portfolios, as well as being unconstrained in terms of percentage allocations to equities and bonds, tend to have much more flexibility to invest in a significantly wider range of opportunities. Examples include precious and industrial commodities and carbon credits, as well as property, infrastructure and renewables via investment trusts, and risk premia strategies that take a systematic approach to harvesting a return stream. Some of these options, such as commodities, should be well placed to deal with the emerging risk of inflation.
We know that this approach to investing (sometimes called ‘liquid alternatives’) has been out of favour for several years now. The reason appears to be that, without having delivered materially better returns than balanced funds, the additional complexity and slightly higher fees have turned investors off. However, this is akin to not seeing the advantage of a 4x4 vehicle over a family saloon for many months, until one day you need to head up a mountain track in poor weather. The additional capabilities and resilience of the 4x4 were always there, but just not called upon until conditions changed.
We believe that our proximity to very significant boundary conditions means that investors should look again at the role these ‘4x4’ unconstrained multi-asset strategies can provide as a wholesale alternative to the 60/40 fund. However, the key contention we would make is that basing a portfolio design for the future on the experience of the recent past could be a huge mistake.
Read our full paper ‘Is your multi-asset strategy fit for the future?’, in which we explain in greater depth why we believe it is important to challenge the status quo and consider a more flexible approach to multi-asset investing.
Past performance is not a guide to future performance and your capital may be at risk. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.
Important information
This material is for institutional/professional investors only. ‘Newton’ and/or ‘Newton Investment Management’ is a corporate brand which refers to the following group of affiliated companies: Newton Investment Management Limited (NIM) and Newton Investment Management North America LLC (NIMNA). NIMNA was established in 2021 and is comprised of the equity and multi-asset teams from an affiliate, Mellon Investments Corporation. In the United Kingdom, NIM is authorised and regulated by the Financial Conduct Authority (‘FCA’), 12 Endeavour Square, London, E20 1JN, in the conduct of investment business. Registered in England no. 1371973. NIM and NIMNA are both registered as investment advisors with the Securities & Exchange Commission (‘SEC’) to offer investment advisory services in the United States. NIM’s investment business in the United States is described in Form ADV, Part 1 and 2, which can be obtained from the SEC.gov website or obtained upon request. Both firms are indirect subsidiaries of The Bank of New York Mellon Corporation (‘BNY Mellon’). These opinions should not be construed as investment or any other advice and are subject to change. This document is for information purposes only. Any reference to a specific product, security, country or sector should not be construed as a recommendation to buy or sell investments in those products, securities, countries or sectors. This material may not be reproduced or redistributed without the prior written consent of Newton Investment Management. If issued in the United Kingdom, this material is a financial promotion and is issued by Newton Investment Management Limited. This material may not be used for the purpose of providing any products or services or making any offers or solicitations in any jurisdiction or in any circumstances in which such products, services, offers or solicitations are unlawful or not authorised, or where there would be, by virtue of such distribution, new or additional registration requirements.
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