Diversify your Diversifiers

by | Nov 9, 2022

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By Steve Hunter, Head of Business Development, Momentum Global Investment Management

What a difference a few months can make. After reasonably rewarding markets in 2021, we have witnessed several asset classes posting significant losses so far in 2022, and not just in equities; even the traditional safe haven of bonds has failed to protect, sending some investors into a tailspin.

Market volatility is high, and the economic backdrop is far from encouraging. With inflation at its highest level in four decades and central banks across the globe raising their interest rates, we are likely to see challenges persist for some time yet.

If traditional equity diversifiers like bonds have failed to provide protection as their correlation with risky assets has risen, then what can investors utilise to diversify their returns, lower portfolio volatility, and potentially provide smoother returns? The answer could lie in diversification and taking a truly multi-asset approach.

Stock markets are volatile creatures and while historically they have reliably delivered strong returns when held for the long run, constantly changing current market conditions are impacting short-term returns. You cannot control the market, but you can control how you react to it by using all the levers available. 

Using all the levers – Style diversification, a forgotten element

Growth style equities have performed well for the past decade supported by a low inflation and a low interest rate environment. The changing markets in the past year have seen value style equities, supported by higher inflation and increasing interest rates, now leading on returns, alongside quality equities; large, established enterprises and market leaders who have continued sedately to deliver. 

We believe that blending these different equity styles is a key starting point to diversifying portfolios given their different performance signatures in different market conditions.

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Source: Bloomberg Finance L.P, Momentum Global Investment Management.  Data as at 31 July 2022. Based on US Dollar returns

Navigating bond and credit markets 

Although the current economic backdrop for credit and bond markets is not particularly supportive, if navigated well they remain an important long-term diversifier.

We consider the key to investing in these markets is incorporating shorter duration to mitigate interest rate shocks and inflation-linked bonds to mitigate rising inflation, alongside more traditional credit markets.

Bringing alternatives to the fore

Generally, the risk/return profile of tangible and well-researched alternatives can be seen to sit between that of equity and fixed income. In many cases, they are less volatile than equities with sustainable returns often with an element of inflation linkage.  

They are obviously not immune to market movements both positive and negative however research and diversification across the different sectors of infrastructure, property, private equity and specialist financial can play a key part in shaping a suitable portfolio.

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