But this positive investment outlook doesn’t come without significant threats to a portfolio, and it is important to protect your holdings from the dangers of the current environment.
I think the key threats for income focused investors right now – namely, uncertain global growth, the tapering of recent central bank measures like QE, and the downward pressures on yields across the market – are best tackled using a multi asset approach.
The ability to switch between asset classes is crucial in an environment like this one, where income is in short supply, and the behaviour of assets changes throughout the market cycle. I’ve set out three of the key threats facing investors today, and highlighted some ways to position a portfolio against them.
Global growth is unsteady
The most obvious risk to investment portfolios is that – despite largely encouraging headlines – global growth remains unpredictable.
The slowdown in China has created a ripple-effect, particularly in broader emerging markets, and looks set to continue as the country’s government rebalances its economy.
Performance of indices over 3yrs
Source: FE Analytics
At the same time, recent events in the Ukraine have reminded us of the risk of geopolitical unpredictability, and have the potential to continue for some time to come.
A bounce back is expected this spring for the US, where data was weak in the first part of this year, largely due to poor weather.
But even here, in this power engine of the global economy, the benefit of the recovery is yet to be fully felt by the consumer – and until this happens, the reliability of growth is unassured.
Clearly, investors should diversify their portfolios across different regions to protect against the risks posed to individual countries as growth continues.
But beyond this, I have recently taken a more cautious approach with the multi asset income funds I manage, reducing their overall risk profiles by making slight cuts to holdings in more growth focused assets like global dividend stocks.
Instead, I’ve added more traditional, longer duration income-generating assets – like investment-grade bonds, for instance – with the aim of boosting income, preserving capital and balancing risk.
I do remain positive about prospects for global growth, but since recovery never happens in a straight line, it makes sense to include some lower-risk options in a portfolio to see you through bumps in the road.
QE tapering comes with various side effects
Early in 2013, when the Fed hinted at plans for the tapering of its quantitative easing (QE) programme, markets were volatile as investors worried about the impact.
While the policy was never going to last forever, uncertainties about the timing and repercussions of its rollback were problematic.
Now that tapering is underway, markets are clearer about the end of QE, but it is affecting different income assets in different ways.
For example, as tapering began at the start of this year, we saw a sharp fall in emerging market debt.
Performance of index in 2014
Source: FE Analytics
The flipside of this poor performance was that yields were forced up to an attractive level, so – from the profits we took through our equity holdings – we reallocated to emerging market local currency debt.
When positioning your portfolio for the long term, think carefully about the impact of monetary policy (and its gradual reversal) on each asset class you hold.
The hunt for yield may have gone too far in some regions
In an environment where income is scarce, the global hunt for yield continues. High yield bonds have seen strong performance, and this is particularly true in Europe.
As a result, the strength of these assets now means that valuations are starting to look stretched relative to their fundamentals.
Yields are also driven downward by continued high demand for income. The fact that Greece’s largest bank, the CCC-rated Piraeus Bank, was able to issue a €500m bond at a yield of just over 5 per cent* (when US CCC-rated corporate bonds are currently yielding 7.5-8 per cent) suggests that the reach for yield may now have gone too far in Europe, and I trimmed back my portfolios’ exposures to European high yield bonds in March.
But protecting your portfolio from the threat of low yields needn’t mean missing out on assets that should do well during the recovery phase of the economic cycle.
‘Hybrid assets’, which offer potential for both capital growth and income, should continue to do well in this environment.
Investment in infrastructure and loans can not only provide an attractive level of income, but also diversification benefits due to low correlations with more traditional assets as well as some protection from inflation.
Key portfolio threats are best met with a multi asset approach
Each of these three threats to portfolios centres on the impact of asset class decisions. Now, perhaps more than ever, many investors are seeking stable and sustainable income versus the unpredictability of individual asset classes.
In an environment of low yields, uncertain growth and QE tapering, a multi asset income solution can offer the important benefit of diversification in a single fund, and benefit from the tactical decisions of experienced managers, who can position a portfolio to take advantage of the opportunities unpredictable markets can offer.