With changing regimes, investors need to think differently
(Runtime: 5:00. Read the audio transcript.)
To filter out the noise of volatile markets, investors need to shift their mindset, says Leonie MacCann, senior multi-asset portfolio manager with Irish Life Investment Managers.
She said the world economy is experiencing a regime shift marked by higher interest rates, higher volatility, and greater potential for dislocation and dispersion.
“In that kind of environment, your core investment principles and your focus on longer-term strategic asset allocation is even more fundamental because you need to be able to see through more market noise,” she said. “But with changing regimes, you do need to think differently, as well. You need to have enhancements that add to that core investment focus.”
Among the enhancements needed to find returns in a hostile environment are flexibility and nimbleness, and the ability to take advantage of opportunities as they present themselves.
“Risk management is most likely going to be even more important in this new regime,” she said. “I think it’s going to be really vital to manage increased risks.”
She said investors will likely be penalized for clinging to hopes of a return to low interest rates, low inflation and globalization.
“There needs to be a shift in mindset that that period is gone,” she said. “That regime is gone.”
In the current moment, investors face economic turbulence, potential for policy mistakes, greater geopolitical risks, stretched valuations and bubbles, and concentrated equity markets, she said.
In such an environment, managing risk starts with constructing multi-asset portfolios using quantitative tools and techniques that illuminate risks from both backward- and forward-looking perspectives, she said.
MacCann said she also looks for opportunities to apply specific risk-management strategies like put options.
“It should be noted that risk management doesn’t mean no risk,” she said. “Absolutely not. You have to take risk in order to generate returns. What risk really means is that there can and there will be down days.”
One side effect of the recent rise in interest rates is a renewed interest in fixed-income products.
“We’re now seeing an environment where bonds are back. That’s something we haven’t been able to talk about for a very long time,” she said. “We’re seeing levels of yields that we haven’t seen in over a decade.”
She pointed out that U.S. and Canadian 10-year yields are at their highest level since 2007. In fact, most fixed-income yields are at the higher end of their 10-year range.
“This does create opportunities. Yields are expected to fall over the next 12 months, as historically yields have fallen post the peak in policy rates. And we’re either at or very close to peak policy rates,” she said. “So that should be a positive return driver from those starting yields.”
Within equity markets, MacCann said she is seeing greater divergence and valuations across a variety of regions relative to the U.S., where expensive valuations persist.
Global, developed-market equities ex-North America are discounted about 30% compared to U.S. equities, she said. “If you were to look back over the last 20 years, that average discount has been about 14%. So, they’re currently trading around 15% to 20% cheaper than they have over the last 20 years.”
There’s also a discount in small-cap equities, she said.
“In part, it’s because of the growth outlook,” she said. “Being able to allocate to them when they’re trading at discount — where more typically they trade at premium — gives us a good entry point, and as economies recover and you enter in the new cycle, they should be well positioned to recover from that.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.
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