David Aujla, Investment Strategist on the Invesco Summit Growth range of funds, looks at how to avoid building binary outcomes into a portfolio.
By now I suspect we are all used to the question often posed at the start of every year, whether it is a new calendar year or a new tax year. The question can take different forms but it is essentially asking the same thing: Where should I invest my money this year to get the best returns?
The trouble is to answer that question correctly is extremely difficult. It means taking a very short-term view and also relies on being right every time. That is both unlikely and unsustainable. While the upside returns potential from such an approach could well be compelling, the downside potential is much less so. It leaves investors in a binary outcome situation, with very little protection.
Returns can vary considerably
Picking a market that will perform well each year is no easy endeavour. Looking back over the last 15 calendar years it is clear that there have been significant differences in return between the best and worst performing asset classes globally.
In 2017 for example, the difference in returns achieved for those invested in equities and those invested in commodities was around 17%. Similarly, bond investors achieved around half of the return that equity investors did. Where you invested your money still made a meaningful difference.
Looking within rather than between the major asset classes, the picture is similar. In the bond market (see Figure 2), the returns varied markedly between high yield, investment grade credit and government bonds.
Similarly, different equity regions performed well at different times (see Figure 3), despite what has felt like persistent US equity market leadership over the last decade.
For UK investors exposed solely, or heavily, to our home equity market in recent years, it is clear that this has been at the expense of returns.
A more pragmatic approach
Is there a better way to allocate capital? Taking a multi-asset approach means building a more diversified portfolio of assets that is less susceptible to the 'feast or famine' of short-term binary decisions. While this approach may mean that investors miss out on being fully exposed to the best performing asset class, region, or market in a given year, those investors also avoid the pain of being solely exposed to the worst performing ones too. This is particularly important in falling markets as demonstrated in 2018, 2011 and in 2008 (see Figures 1, 2 and 3).
Multi-asset investing is a pragmatic approach which allows investors to express preferences for those asset classes and regions that they think have the potential to perform strongly over the long term. At the same time it could afford them downside mitigation, greater risk-adjusted returns potential, and improved sustainability of returns that a truly diversified portfolio can bring. After all, the wider the spread across various asset classes, regions or markets, the lower the correlation between them, hence the lower the level of overall risk.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested
This article is for professional clients only and is not for consumer use. All data in this document as at 24 April 2019 unless otherwise stated.
Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice.
Invesco Asset Management, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire RG9 1HH, UK. Authorised and regulated by the Financial Conduct Authority.