When thinking about how to construct multi asset portfolios, a question Premier Miton always have front of mind is: how much portfolio risk is appropriate? Anthony Rayner, fund manager in the Macro Thematic Multi Asset Team, gets into the detail.
Questions that follow on from appropriate portfolio risk are: how much equity risk is optimal in portfolios, which equity baskets should drive that risk and, last but definitely not least, how best to diversify that equity risk?
Taking each of those in turn, equity risk is generally the dominant risk in most multi asset portfolios and as such tends to be at the top of our hierarchy of risk considerations.
Our investment approach is driven by a very practical process where we look for market signals as to how much equity risk to take, rather than simply “having a view”, and this helps to reduce contamination through emotional biases and blind spots.
The approach, above all else, is pragmatic, and looks for macro and thematic ideas where the underlying investments have positive price momentum.
This belief in positive momentum is driven by the view that trends generally continue for longer than most investors think they will.
This process not only identifies individual instruments with positive and negative momentum, it also highlights areas where momentum is broadening out, as well as narrowing, and therefore helps us gauge the healthiness, or otherwise, of the market. This all feeds into the decision as to how much equity risk to take.
Turning to the second question, namely, which baskets should drive equity risk? Above all else, we build conviction in areas where momentum is steady and, preferably, where it is diversified across different sources of risk, for example different sectors, so that risk doesn’t become too concentrated. In this way, we build equity baskets of macro and thematic ideas.
Turning to the third question, of how best to diversify equity risk, often the first place to look is within equity itself, for example having a broad range of sectors. Looking at non-equity opportunities to diversify equity risk, there is a common view that bonds are a good way to diversify equity.
Bonds sometimes do diversify equity but, for extended periods, they don’t. In fact, when inflation is elevated, bonds tend to add to equity risk. So we try to retain an open mind as to how best to diversify equity risk, including a basket of commodities, such as oil, agricultural commodities, industrial metals and precious metals.
So, what can we say about the current environment? First and foremost, higher bond yields are making life more difficult across assets, as the cost of money is now higher.
Not only does this make investors rightly more demanding, in the real economy higher yields are making life harder for governments, consumers and business.
There are a number of long term forces driving yields higher, such as fiscal spending, but there are also more recent drivers, such inflation and growth, which are being driven largely by the oil price and tech growth, respectively.
This then begs the questions as to where the Iran war is headed and when the AI bubble will burst? These are tricky enough questions to answer as the best of time, but especially when taken together. It’s easy to get stuck in a mess where you feel the need to have a binary, time specific view.
However, using our macro thematic framework, including the filter for identifying positive momentum, it becomes clearer about what to do.
In relation to equity sectors, the momentum within tech is becoming narrower and narrower, this is consistent with moving closer to the tech bubble bursting. However, there are signs of improving breadth across other sectors, including healthcare and staples.
Whether these areas can, at some point, take the baton from tech in a sustainable manner is uncertain.
This leads us to be constructive but cautious around equity risk and to diversify across sectors, selling tech where its positive momentum is fading and adding to defensive sectors but, above all else, ensuring we have liquidity across portfolios, in order to act quickly if need be.
In addition, we add to equity sector diversity by increasing diversification in non-equity assets. Namely, increasing the duration and geography of government bonds, now including Japan and Australia, while we also retain our commodities basket for their diversifying power. In short, we are reducing risk but staying invested.
Main image: pie chart, investing, diversify,cht-gsml-q21XvpB7uQU-unsplash
