Market analysis: Portfolios need diversity and creativity

About $12 trillion – 36 per cent of total global government bonds – are trading at a negative yield. Kham / Reuters

A low-growth, low-inflation and low-interest rate world implies lower nominal returns. After years of accommodating central bank policy, the amount of negative yielding sovereign debt is at all-time highs.

While this creates challenges for income-seeking investors, there are opportunities for investors looking beyond traditional fixed income. Demand for income is likely to persist, if not intensify further, given changing global demographics and central banks’ desire to suppress bond yields in both the government and corporate markets. In such a world, investors will increasingly be forced to diversify their portfolios away from low-risk income-generating assets towards a broader set of asset classes.

In recent weeks, increased political uncertainty has fuelled even greater demand for safe haven assets such as German bunds and US Treasuries. While the true ramifications of Brexit and other political events in Europe are yet to be fully comprehended, it is important for investors to remember the basic principles of valuations. With yields so low, one has to question the safe-haven status of a 10-year bund with a negative yield. The vicious sell-off during the taper tantrum of 2013 serves as a good reminder of short-term capital losses potentially associated with holding such richly valued assets.

In the past, traditional fixed-income investors allocated a significant part of their wealth in core government bonds. With about $12 trillion – 36 per cent of total global government bonds – trading at a negative yield, navigating fixed-income markets remains a challenge. Hence, investors are increasingly looking for differentiated sources of yield and returns.

Demand for multi-asset income funds increased significantly over the past 15 years, with the number of funds increasing fifteen-fold over the period. In this low-yield environment, high-yielding bonds and stocks might seem like a crowded trade. However, we believe a multi-asset approach can take advantage of global opportunities and deliver more consistent returns than a single-asset investment.

By accessing opportunities in different asset classes and geographical markets, diversification may improve portfolio performance while lowering volatility. At this point in the cycle, being aware of concentration risk in one specific fixed-income sector, country or region, becomes even more relevant.

In equities, the opportunity to invest globally provides more diversified sources of income from different regions and sectors. Ultimately, owning different asset classes with low or negative correlations should provide diversification benefits and increase risk adjusted returns.

Continued global central bank action, whether you interpret it to be monetary divergence or increasingly what looks like convergence, will lead to relative value opportunities in rates and credit markets. By allocating across asset classes and being dynamic, one can logically see why a multi-asset solution to income is gaining increasing investor interest.

At a time of uncertainty and one of continued prospects of low growth ahead, on a risk-adjusted basis credit looks more attractive than equities, and as such it should have a significant allocation in a multi-asset class portfolio.

In credit, a diversified approach and a focus on shorter duration will help to reduce the impact of rates volatility and optimise risk adjusted returns.

From a regional perspective, at present we find a better risk-return profile in high-quality US high yield compared to European high yield because of the higher level of yield and greater political certainty.

Despite the fundamental challenges faced by many emerging market nations, investing in both their debt and selective equity should also be considered as part of a broader multi-asset strategy as it offers diversification and yield enhancement.

After years of emerging markets underperforming developed markets, 2016 may well be the year we see this trend reverse.

Given the current market environment of very low yields and easing monetary policies, we believe that a dynamic portfolio with a multi-asset class approach can take advantage of global opportunities and be a very attractive investment for income-seeking investors.

Nicholas Roberts is a senior portfolio manager at JP Morgan Private Bank and Ilaria Calabresi is a vice president at JP Morgan Private Bank.

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