This article originally appeared in Boersen Zeitung on 23 November 2013.
An essential function of asset managers is to develop new and innovative investment solutions that not only meet but, more importantly, anticipate and respond to the evolving market conditions and changing client needs. The frequency with which new investment strategies and solutions have been developed in recent years reflects the speed at which the industry has been required to respond to the rapidly changing and dynamic global investment landscape since the start of the financial crisis in 2008.
Most noticeably, product innovations now predominantly follow a clear pattern: Investment solutions are moving away from traditional, highly restrictive and regionally-focused strategies towards more globally-focused strategies, applying a broad toolkit and global opportunity set to achieve return objectives that are increasingly unobtainable with traditional benchmarks. In addition to broader, global investment solutions, investment strategies also are offering alternative fixed income based solutions – ranging from the ability to go short, use quantitative tools and combine allocations across asset classes and market segments.
However, recent market volatility, including a correction in emerging markets, and the prospect of deflation in Europe amid ongoing economic sluggishness, may have some investors concerned that “going global” is not a panacea for their portfolio concerns. It never was. Investors should always give careful consideration to the nuances of markets and potential for greater volatility when they go global. But expanding one’s opportunity set to include multiple regions and market sectors is a critical approach to enhancing return potential and managing risks in a world that remains awash in central bank activism, political uncertainty and major economies operating below potential.
Investors need to rethink traditional labels when evaluating risk
To illustrate this point, consider a conservative investor who invested in euro-denominated sovereign bonds over the last decade for the fixed income portion of his or her portfolio. First, such an investment approach would have achieved only limited performance by missing some key global trends, such as growth in emerging market bonds, both in hard and local currencies. Second, while the investor might have considered the chosen investment strategy to be a conservative core portfolio, it could have left the investor with poor returns and a significant amount of credit risk as the eurozone debt crisis spread and impacted spreads in its periphery. In the U.S., investors focused on U.S. Treasuries over the last decade would have faced similar challenges in reaching their investment objectives.
More broadly, investors around the globe have been forced to rethink the concept of “risk-free” assets. Credit risk is no longer a phenomenon of corporate bonds and emerging markets, but of countries that have previously been considered developed nations.
There are many sources of uncertainty in this central bank-intermediated world Unprecedented central bank activism clearly has had a dramatic impact on global markets and it is evident that bond markets and bond investing are subject to changes that will be with us for years to come. Central banks should be at the top of each investor’s list of things to watch.
With so many central bankers suppressing short rates (and in some cases buying bonds as well) in order to spur economic growth, investors have had to seek out new sources of meaningful returns by moving to the riskier outer ranges of the investment spectrum.
And it is still not clear if central banks eventually will be successful in achieving full employment or boosting inflation to their target levels.
For now, we remain in an artificial market environment, one in which valuations and underlying fundamentals are disconnected from each other (Figure 1). Therefore, the question investors need to ask themselves is how long the liquidity wave of “cheap money” will continue to support markets – sooner or later, central banks will start to withdraw from their unconventional monetary policies and send markets on a bumpy journey back to fundamentals. Amid all these uncertainties, investors need to consider new approaches.
Going global can help
Looking ahead, investors will need to think and act more flexibly and more globally to meet their investment objectives in this new landscape. Investment strategies that are focused on a specific region or country constrain an active manager’s ability to react with agility to the changing landscape of risks and opportunities. A global, less constrained approach can provide a broader opportunity set and the flexibility to select the best investments across regions. A global investment universe allows investors to cope with the fundamental shift in the world economy and the multi-speed growth paths of emerging and developed markets.
In our view, there are four key concepts for investors to consider:
- Capture relative value across multiple market sectors. In the New Normal, credit risk is no longer limited to corporate issuers and emerging countries – even developed countries that have previously been considered pure plays on interest rate risk now show signs of credit risk. To capture opportunities across the capital structure, asset managers need the flexibility to be able to invest in a broad opportunity set – from sovereign and supra-national to corporate issuers – and across seniority levels of specific issuers.
- Broaden interest rate strategies opportunistically. With yields at historic low levels but globally volatile, adding interest rate risk in the form of maturity extension will unlikely deliver the market return it used to deliver pre-2008. In contrast, there may be times when an investor will need to protect against rising interest rates or ideally take profit on a rise of yield levels. Globalisation of interest rate exposure works best with the discretion to manage duration more actively, including going short to benefit from an expected rise in yields.
- Evolve investment strategies to better match investment objectives. Traditional approaches concentrated on delivering outperformance versus a benchmark that rely generally on a long-only approach may not be sufficient to meet investors’ goals. Going forward, there may be times when such strategies will not be able to rely on a positive market beta to deliver positive total returns. Hence, the trend towards more absolute-return-oriented approaches will most likely be permanent, as well as the option to go short.
- Apply a consistent global investment process. Finally, it is important to have an underlying investment approach that is global in nature, both with respect to spectrum and capabilities, in order to successfully manage global mandates. Successful investment solutions require a comprehensive and frequent analysis across the capital structure, encompassing geography, market segments and asset classes.
Therefore, when we speak of global, all these aspects come into play. A global opportunity set and flexible investment approach do not mean that traditional, long-only strategies may not make sense for certain investors and, in certain situations, even a global investor may choose a tactical exposure that very much resembles traditional positioning. But rethinking traditional approaches enables investors to better navigate a fluid investment landscape marked by ongoing change and limited market returns.