Multi-asset strategies offer an alternative in liquidity driven markets

Different from positioning based on stages in the business or credit cycle or general “risk-on/risk-off” swings, the liquidity trade creates a backdrop where both risky and safe assets perform well. Basically it causes all assets that have a claim of future cash flows to perform well. The latter can be either coupon or dividend payments that cause an asset owner to outperform cash over time.

This means that generally safe categories (government bonds), yield plays (credit and real estate) and growth assets (equities) all do well once the liquidity trade is in play.

One could argue that ever since markets became convinced that the European Central Bank and the Bank of Japan would join the Federal Reserve in its willingness to “do whatever it takes” with its liquidity ammunition to reflate the economic system, the liquidity trade has been one of the most dominant forces in financial markets. Ever since Mario Draghi made his famous speech on 26 July 2012 on potential ECB action to support the euro, and in late 2012 the political and policy regime shift in Japan took place after Shinzo Abe’s election victory, it was clear that the three largest central banks in the world were willing to fire on all liquidity cylinders to fight off global deflation risks. Both equities and real estate floated up more than a cumulative 50% since this liquidity wave started rolling, while German Bunds have risen a little less than 20%.

The above shows that investing in multiple asset classes can reap attractive returns. However, government bond yields are expected to remain low for the foreseeable future and hence offer little return potential. The liquidity trade is thus expected to remain a dominant force.

Although the Fed could start to hike rates in December already, it is widely expected that the path of rate hikes will remain very shallow. ECB President Draghi has hinted on an extension of its Quantitative Easing program in December, while also the BoJ is expected to ease further.

The low bond yields have left traditionally conservative investors with limited options where to invest. For example, large institutional investors such as pension funds, which traditionally invest a relatively large part of their portfolios in government bonds, are forced to search for higher yielding alternatives given their actuarial targets. One can argue that the group of conservative investors will only increase given factors such as demographic changes, stricter regulations and the collective memory of the 2008 financial crisis which has reduced the ability and/or willingness of previously more risk-seeking investors to take risk.

Flexible multi-asset strategies offer traditional bond investors an alternative by providing access to a wider set of return opportunities while limiting the overall portfolio risk.

Investors with moderate risk profiles would therefore be better off if they switch a part of the interest rate risk in their bond portfolios into better-rewarded risk-taking in other asset classes, without increasing the overall portfolio risk. Multi-Asset funds aim to provide attractive returns while running a risk level comparable to that of a diversified bond fund.