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FUND MANAGER'S TAKE

Multi-asset investing in a challenging global economic environment

Value can be added by adapting to market behaviour.

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In the Euro area (above) and also in Japan, monetary conditions are still being loosened. The result of this is that on a net basis, global liquidity continues to expand.
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THE popularity of multi-asset solutions is clearly seen by the significant inflows finding their way into the sector. However, diversified multi-asset approaches should be considered throughout a cycle. History has shown that differences in returns between asset classes can be quite significant with also large differences persisting between regions and sectors.

Many things have changed since the start of the global financial crisis in 2008. As a result of the crisis, central banks around the world have lowered their key interest rates and engaged in unconventional easing measures. This has led to an unprecedented decline in government bond yields in developed market (DM) economies despite recent steep corrections in yields on for example, German government bonds in April and May this year.

Multi-asset funds give investors the opportunity to replace part of the interest rate risk they face in their bond portfolios with potentially better rewarded opportunities in other asset classes. When we return to an environment of greater investor confidence and improved global growth conditions, continuing global economic and monetary policy will continue to lead to return differences between asset classes. Different regions will be in the varying phases of the cycle and sectors will respond in a variety of ways. Furthermore, the frequent occurrence of unexpected events also rewards those with the ability to respond quickly to changes.

Recent developments

Ongoing uncertainty about emerging markets (EM) had a spillover effect into DM assets in August resulting in a sharp rise in DM equity market volatility. Volatility rose much more compared to other periods of uncertainty in past years. In fact, the volatility spike (as measured by the VIX) was comparable with late 2011, although the duration of severe uncertainty was much shorter. Currently, volatility is still elevated, but has come down from extreme levels. At the centre of the uncertainty were EMs. The Chinese currency devaluation drove many other currencies in EM down. EM currencies have been weakening for some time now and quite a few currencies have fallen significantly against the US dollar since the start of the year. The spillover of the EM volatility was most noticeable in equities and commodities. Other risky assets were also not spared and we saw for instance a widening of Euro area investment grade and high yield spreads.

One important way in which the EM turmoil is impacting DM government bond yields is through inflation expectations. EM weakness has resulted in declining commodity prices, which has strongly impacted inflation expectations over the past year. Market worries about the overall outlook for global economic growth and monetary policy could cause also real yields to decline. However, this does not seem to be the case at this stage. Market worries about the overall outlook for global economic growth and monetary policy could cause real yields to decline but this does not seem to be the case at this stage. There is still a slight upward trend in real yields in the US and the Euro area. Both US and the Euro area real yields rose in August, which more than compensated for the commodity-driven decline of inflation expectations. Whether this trend continues will depend on the level of contagion of the EM crisis to the developed market growth environment.

Outlook

In the medium term, we expect a moderate global economic recovery which supports risky asset fundamentals. From a monetary policy perspective, we expect the Fed to move slowly on its path of normalising monetary conditions, which implies a process of slowly increasing yields in the coming years. In the Euro area and Japan, monetary conditions are still being loosened. The result of this is that on a net basis, global liquidity continues to expand. However, the transition into the exit may require some adjustment by financial market participants. We expect that we stay in a relatively low inflation environment for the time being.

For the moment, markets do look fragile with a life of their own. The EM environment remains very weak, with the potential of a spillover into DM. We have adopted a more defensive asset allocation stance over the past couple of weeks. Since all investors closely monitor developments especially in China, volatility is expected to remain high. In such market circumstances, value can be added by adapting to market behaviour in order to exploit new opportunities available in the cross-currents of underlying fundamentals and market behaviour.