DIY Investor Magazine
/
2015 Issue
7
WE ARE LIVING IN A VOLATILE WORLD OF EXTREMES.
HIGH EQUITY PRICES MEAN LOWER FUTURE RETURNS.
LOW BOND YIELDS MEAN LOWER FUTURE RETURNS
AND THE LIMITED PROTECTIVE POWER OF FIXED
INCOME IN MULTI-ASSET PORTFOLIOS
economies are entangled. What happens in Europe
affects the economic fortunes of China and Japan.
Their fortunes impact those of the US.
And the mighty economy of the US, with its colossal
consumer base, affects what happens in the rest of the
world.
When the US consumer sneezes the rest of the world
catches a cold. This integration locks together the
global economy, losing some of the risk-mitigation
properties of global diversification.
In a world of extremes and uncertainty about economic
growth, changing sentiment and news can cause large
shifts in asset prices, injecting volatility into the system.
When inflation expectations are so low, any shift in
perception, due to a rise in oil price or upbeat forecasts
of economic growth, can lead to a swift hike in bond
yields. When equity prices are touching the sky, any
disappointment relative to expectations can lead to a
swift correction.
And when the global economy relies on experimental
QE, any rhetorical glitch by policymakers or political
instability can lead to swift movements in asset prices.
Volatility is likely to intensify in this environment.
VOLATILITY
This is not the only factor amplifying volatility. The
proliferation of hedge funds and speculators with
derivatives at their disposal allow them to trade notional
amounts in the billions. Traders can accelerate trends
in the markets, causing asset prices to disconnect from
fundamentals.
Logically, high asset prices today translate into low
future returns. These challenging low expected returns
are likely to be accompanied by a volatile regime.
The end of QE in the US, political difficulties in Europe,
Japan struggling to exit its prolonged recession and
slowing down in China are likely to further increase
uncertainties.
Uncertain oil prices, an increasingly complex
geopolitical backdrop and a transformational,
integrated world, just add more fuel to the fire.
The result: We are living in a volatile world of extremes.
High equity prices mean lower future returns.
Low bond yields mean lower future returns and the
limited protective power of fixed income in multi-asset
portfolios. Low rates and low inflation mean cash and
conservative assets deliver meagre returns, pushing
investors to riskier instruments, only to further inflate
bubbles.
This is a challenging global financial market. And we,
the investment professionals, need to deliver risk-
adjusted returns in line with the expectations of our
investors. There are no excuses, as we are going to be
measured by the outcomes we deliver.
THE SOLUTION
So what should investors do to venture through this
uncharted territory? The answer is Diversification,
Selectivity and Dynamism. Diversification. One of the
oldest tricks in the investment book to reduce risk is
diversification.
In a world of low returns, high risks and correlated
markets diversification needs to be broad across
global assets. Global multi-asset investing is the way to
achieve proper diversification.
