The third article in our series is about the macro environment, especially as it relates to the impact of ultra-low rates on asset allocation, and the balance between inflation and deflation risks going forward.
Ultra-low rates, but not everywhere - Panel members agreed that interest rates may be ultra-low in the West and Japan, but not in China, highlighting the fact that global investors will naturally seek higher income and yield in places where they persist, whether it be in alternative assets, alternative strategies or capital markets like China that are expected to deepen further in 2021 and beyond. Chinese equities have already been in global asset allocation portfolios for some time. Expect Chinese fixed income to become more prevalent in years to come. De facto, this means global investors will start lending more to China going forward. A recent article in the Financial Times speaks to this point.
Demand for alternatives – Given current and expected levels of yield in the most mature fixed income markets, expect investors to seek higher income outside of investment-grade government and corporate bonds. Beyond high yield and private debt, such opportunities include cross currency exposure, spread positions across the yield curve, relative value across the credit spectrum, and volatility exposure. Because they require more skill, such exposures are expected to favour reputed active managers and active strategies, which, in turn, may utilise passive vehicles to achieve their objectives.
Inflation or deflation? Which is the greater risk? - Since the answer depends on where one is based, panel members provided nuanced answers explaining the importance of timing in addition to location - a key point considering that five-year inflation expectations in the UK, the US, the EU and Japan are 3.5%, 2.0%, 1.0% and 0.2% respectively at the moment. When Bob Litterman himself humbly said that his macro-economics training predates the current era, he pointed to the fact that thinking about inflation has evolved substantially in the last two decades, especially since the 2008 global financial crisis. Andrew McCaffery provided a nuanced analysis, saying that while deflationary forces are still there, we could see inflationary pressures building up in the short to medium term. This week’s Economist article on the topic – prognostication and prophecy – provides interesting background on this topic, especially in the context of a pandemic.
The ALPIMA platform helps financial firms and professional investors create investment strategies and personalised portfolios taking into account specific market views and other preferences.
For example, in a world of prolonged ultra-low rates, revised return expectations on fixed income assets can meaningfully shape asset allocation by reducing the optimal fixed income allocation within portfolios, as discussed in this piece. We intend to write more on this in future articles.
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