The importance of active management
Hear from Trevor Greetham, Head of Multi Asset at Royal London Asset Management (RLAM) as he looks at the importance of active management in multi-asset investing, some of the processes RLAM use to inform their investment decisions and what to look out for in 2023.
My name’s Trevor Greetham. I'm Head of Multi Asset for Royal London Asset Management.
Why is active management important during volatile markets?
Markets have been unusually volatile over the last year or so.
Our portfolios have been relatively resilient because we believe in spreading investments across a wide range of different asset classes to give a smoother journey as part of the long-term investment strategy that we employ.
If you look at the last year, we've seen negative returns from government bonds as Central Banks scramble to raise interest rates to fight inflation.
Stock markets have also been volatile, but from a sterling investor point of view, the weakness of the pound has dampened the negative impact of falling stock markets overseas.
Commercial property, though, has been very strong over the last year. Commodity prices rose very sharply, and we include commodities in our portfolios.
The economic outlook as we speak at the moment, is cloudy.
With these interest rates going up to fight inflation, we're expecting to see recessions in a wide range of different economies over the next year or so, and they may not be fully priced into financial markets at this level. And that could mean further volatility ahead.
But we believe in this environment, it's really critical to be an active manager, to move investments around, depending on where you see the rewards and the risks at a particular point in time.
And we have a strong track record of managing multi-asset portfolios through lots of different crises that we've been through in the past, all the way from the global financial crisis, through the Euro crisis of 2012, the Brexit referendum in 2016, and of course, covid.
Why is active management so important in multi-asset investing?
People always invest in multi-asset funds with an outcome in mind.
People have a savings objective. For example, they may be saving for their pension, in which case they're looking to grow their investments over the long run and beat inflation if they can.
It's very important also to design portfolios that are suitable for different individual attitudes to risk.
For example, younger investors can generally take greater investment risk and seek greater returns, because a lot of their future pension pot, for example, will be based on contributions to the pension they haven't even invested yet.
So they can take some bigger risks with their current pension pot, whereas older investors tend to be a bit more risk averse.
So we build different portfolios to suit different levels of risk.
We think it's very important to be an active investor, and we'd actually argue there's no such thing as a passive multi-asset fund. The choice of asset classes to include in the first place is an active choice.
You should be adjusting the asset mix as the investing environment changes, both in terms of the valuation, which gives you a view of longer term returns, but also shorter term developments in for example, the business cycle.
Which asset classes do you include and how do you decide the right mix?
The performance of different investments can vary wildly from year to year, particularly going into and out of recessions. To get a smoother journey, you have to mix different investments, and all of the investments we include in the portfolios make sense in the long run.
For example, company shares, and commercial property are investments that tend to give you a stake in the real growth in the economy. They've shown very good long run characteristics of beating inflation across multiple decades.
We have some commodity exposure in the portfolios, just in case of short-term inflation shocks.
And we also have government bonds, and government bond returns tend to be a bit of a stabiliser in portfolios, particularly going into a recession or a slowdown when the prospect of lower interest rates can mean better returns from bond markets.
As we've described, we tailor each portfolio for a specific level of risk appetite. But that isn't the end of the process, that's the start of the process.
Many passive funds just have stocks and bonds, and they will say, about particular levels of risk, might be suited to a 50:50 mix or a 60:40 mix, whatever it might be.
Because we've got more asset classes, we tend to ask more questions than just what is that long run level of risk? We're interested in resilience to shocks.
What if inflation rises? What if there's a recession? Can we build in resilience to those different environments?
And we also like to think about the medium-term return expectations for different investments as well.
A good example a couple of years ago, when interest rates were really, really low after the covid shock was first hitting the economies, government bond yields were really, really low, which meant quite a low prospective return and we had a very low exposure to government bonds in our portfolios.
As bond yields rise, those investments get more interesting as well. So it's about risk, yes. But it's also about resilience.
How does active management impact day to day investment decisions?
Different investments offer their best returns at different times.
And the time they offer their best returns is often linked to what's going on in the global business cycle. Whether there's an economic recovery, a slowdown, or a recession, for example.
We have a research-led process that looks through lots of history to work out the factors that can help us to make good investment decisions.
And we feed those investment signals into a very experienced team of investors, who can apply their own experience and their own judgement in deciding what to do in the new circumstances we always find ourselves in.
We review the asset mix of our different portfolios on a daily basis, and if necessary, we can make changes as information starts to change about the world that we're living in.
We think it's very important to be focused on those factors that help you add value over the long run, and that to us, is more important than trying to chase short-term returns.
How does the Investment Clock work?
The Investment Clock is a way of linking the performance of different investments to the global business cycle.
We think about it in terms of a clock face and where you are on that clock is determined by what's happening to global growth and global inflation.
For example, when you have a disinflationary slowdown, so weak growth and falling inflation, government bonds tend to do very well because interest rates are cut by Central Banks, inflation expectations are dropping, and all of these things boost the bond markets.
When interest rate cuts take effect and you get an economic recovery, if it's still disinflationary, that's the best of all possible environments for stocks.
Because when you've got a disinflationary recovery, you've got loose policy, interest rates are still low, but companies are suddenly making profits and share prices go up.
When growth is strong for too long, you've got an overheat.
So what happens there is inflation starts to rise as commodity prices are going up, and there's too much money chasing too few goods.
Central Banks then start to raise interest rates, to try to rein in that inflation. And in that stage of the business cycle, the overheat commodities tend to be the best investment.
And then finally, of the four different stages of the business cycle, we have stagflation.
Now stagflation is a slowdown, but with inflation still high or rising.
In stagflation, you’ve got an economic slowdown, the prospect of weaker profits growth from companies, but Central Banks may be raising interest rates. And that combination tends to be pretty bad for stock markets.
It can be bad as well for bond markets.
What should we look out for in 2023?
The business cycle is rolling on.
It's possible that inflation stays high if for example, the war in Ukraine worsens or if China were to relax, significantly, its covid measures and see some stronger growth.
But we think it's most likely that the higher interest rates in most of the world will start to bite, we’ll have a slowdown in activity, accompanied by possibly quite sharp falls in inflation from the current double digit levels of inflation that we're suffering.
In Investment Clock terms, that would be a disinflationary slowdown: the reflation stage of the clock, when government bonds tend to do well.
So in our portfolios, we're likely to shift more money towards those government bonds.
There's an added attraction that because interest rates have risen so much in the last year or so and bond yields have risen, they’re priced to offer a better return than they were a year or two ago.
In terms of stock markets and property, we're still a little bit cautious, because if there is a recession or certainly a period of quite weak economic activity, we could see further drops in share prices.
We could see further drops in the property market, but reflation is the light at the end of the tunnel, because as soon as you've got inflation coming down, it sets off a chain of events that will eventually lead to Central Banks cutting interest rates, and those interest rate cuts will start to stimulate economic activity.
So reflation is good for government bonds. You want to be a bit cautious still about stocks and property, perhaps, but it's the beginning of better times ahead.
"We have a research-led process that looks through lots of history to work out the factors that can help us to make good investment decisions. And we feed those investment signals into a very experienced team of investors, who can apply their own experience and their own judgement in deciding what to do in the new circumstances we always find ourselves in."
Trevor Greetham Head of Multi Asset, Royal London Asset Management (RLAM)
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