Investors need to temper their expectations for the coming years, according to Wei Li, head of investment strategy at iShares EMEA, who says stretched valuations and loose monetary policy has caused a shift in long-held investment strategies. 
“If investors stick to their previous return and also income expectations that is not very realistic,” she said.
“Previously you could get 4 per cent for a government bond but now if you want to get 4 per cent as a very fixed target yield for a portfolio the only places you can go to are really long dated bonds or high yield or emerging market debt.”
Indeed, over the last year, loose monetary policies around the world have meant equities and government bonds have rallied at the same time following moves from the likes of the Bank of England and the Bank of Japan.
In the UK, for example, equities have risen 12.56 per cent this year while government bonds have risen 15.48 per cent.
Performance of indices in 2016
Source: FE Analytics
With other assets including gold and global equity markets rising in tandem, investors have become cautious that what goes up together must come down together.
“Positioning also seem pretty stretched especially in certain parts of the market that we have seen a huge amount of inflows,” Li said, something FE Trustnet will be looking at in an article later this week.
As a result, the outlook for 2017 is unclear but below Li outlines three areas of the market which could perform well in these conditions.
Emerging market equities
While this area has been on a surge so far this year due to investors fleeing developed markets on the back of events such as the Brexit vote and the upcoming US election, Li says structural changes in emerging markets mean they could outperform again in 2017.
“Earnings are starting to come through – so for the first time in over two years we are starting to see earnings momentum in EM equities turning positive,” she said, adding that the stabilising oil price has helped this transformation.
As well as this, emerging market valuations remain attractive compared to the developed market counterparts, despite the rise this year.
The below graph shows emerging markets have been one of the strongest performers year-to-date, returning 34.35 per cent to investors.
Performance of indices in 2016
Source: FE Analytics
Many remain concerned that an interest rate hike by the Federal Reserve could derail emerging markets, but Li says there is reason to be optimistic.
“While we think that the Fed matters a huge amount, a lot of people have been focused on when they are going to hike but people should pay more attention to the path of the rate hikes,” she said.
“From the end of 2016 to the end of 2019 the markets only price in two to three more rate hikes, which are extremely gradual and that is going to be okay for emerging markets to stomach.”
While she says emerging markets will not be able to handle a sharply strengthening dollar, a gentle ‘normalisation path’, especially one backed-up by positive data, should be fine.
“That hiking pace will be okay for emerging market economies, which is why we remain high on emerging market assets because we think that some of the external risks are not as scary as before,” she added.
Additionally, news flow from within the emerging markets has begun to pick up, with China now “in the headlines for the right reasons”.
At the start of the year, the devaluation of the yuan and fears of a hard landing for growth, as well uncertainty over structural reform, were all weighing on markets.
“But more recently we are starting to see China in the headlines for the right reasons. Data in August has been really positive and we’ve started to see signs of the stimulus package at the beginning of the year feeding through to a more stable growth outlook,” Li said.
“So all of that is telling us that the outlook for emerging markets at least in the next three to six months are likely going to be in a pretty sweet spot.”
Emerging market debt
While the above rational also boosts credit in the region, Li says the main driver for emerging market debt is the increasing search for yield.
“We’re in an environment where lots of government bonds are yielding negative and investors remain constrained in terms of their income needs because they still need yield but they can’t find it in traditional assets any more. So increasingly we’re starting to see investors being squeezed out into what are perceived to be the more risky part of the spectrum,” she said.
While the Federal Reserve can have more of an impact on emerging market debt, this search for yield should underpin the market, she says.
Additionally, the area has improved a lot in recent years, with investment grade credit now making up a larger percentage of emerging market debt than ever before.
“Emerging market debt has also gone through a period of credit improvement,” she said, adding that it is “arguably less risky in terms of the investment grade credit rating versus five, seven or 10 years ago”.
Investment grade bonds
The final area Li likes is investment grade bonds, with loose monetary policies around the world boosting demand.
“Structurally speaking we also think that investment grade remains supported because central banks are buying them and we don’t want to go against central banks,” she said.
This is particularly true in the UK and Europe, where the Bank of England recently began a programme of buying corporate bonds, while European Central Bank has been doing so since June this year.
“Based on the latest asset data released, the ECB are already buying a lot and we think this is not only going to support the investment grade market in the regions under consideration,” Li said.
Performance of index in 2016
Source: FE Analytics
Indeed, as the above graph shows, European bonds rose in April when the ECB announced its mew program and again at the start of June (ignoring the large spike caused by the Brexit vote), following it launch.
However, this also been forcing traditional holders of these assets further afield to look for additional yield.
“This is why, in the US, despite the fact that the Fed is not buying [bonds], we think that US investment grade could benefit from this, because we have foreign tourists coming from the UK and Europe looking for yield in the US where there is still a reasonable yield pick-up.”