Note: This article appears on the ETFtrends.com Strategist Channel
By Bryan Novak
If you caught the recent Bloomberg article about the upcoming meeting between Chinese officials and Fed Vice Chairman Stanley Fischer, U.S. Treasury Secretary Jacob J. Lew and other U.S. officials, you may have been struck by how much influence China has gained, even in the wake of last year’s meltdown. Economic policy is the topic on the table, and with the China and U.S. economies more intertwined than ever, the two countries both have a lot at stake.
If the Fed raises interest rates this summer—a move that’s looking somewhat more likely than even a month ago—the Chinese are worried about an exodus of capital that could damage their already ailing economy. Further, movement in the currency markets has everyone on edge. If the Chinese economy takes another dive, U.S. markets may again feel the aftershock. What’s more, Christine LaGarde, the managing director of the IMF, publicly “pleaded” with Janet Yellen in 2015 to hold off on rate hikes. The relationship of domestic monetary mandates and global economic stability is growing ever opaque.
From the Fed’s perspective, their goal is simple (if not so easily achieved): manage the stability of the U.S. economy. If domestic inflation hits the 2% target, interest rates will almost certainly rise. But as globalization increases and emerging markets and economies like China mature, that process isn’t as simple as it once was. Just ask Janet Yellen.
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For investors, this shift has similar implications. As the influence of global economies and events on the stock market has grown, the approach to building successful portfolios is not as straightforward as it once was either. Investing is no longer just about equities or fixed income—or at least it shouldn’t be. To drive returns and address diversification in today’s global economy, investors need a more balanced and highly diversified portfolio that includes a wider range of assets, including equity and fixed income, as well as alternatives such as global currencies, commodities, futures, real estate, and more.
The value of a multi-asset portfolio
There’s no doubt that in today’s changing economic climate, multi-asset portfolios can add more value than ever. First and foremost, there are diversification benefits to holding multiple asset classes as behaviors and market responses differ across asset, solely based on the fact that there response vary to stimuli such as interest rates/inflation, economic activity, and the risk environment. Based on these premises, strategies that actively adjust these exposures can provide value to a portfolio as well. Unlike Janet Yellen and the Fed, portfolio strategists have the luxury of driving their own policies based on global economic trends. As market shifts occur, portfolios are able to adjust accordingly. Having the flexibility to construct portfolios that move across and within asset classes, multi-asset portfolios can take a tactical approach to asset allocation that can help reduce volatility within a portfolio and mitigate the impacts of asset-specific drawdowns.
Recent market events have highlighted these dynamics. Large swings in the price of oil and foreign currencies (primarily the Yuan) delivered a major hit to the US economy over the past 12 months, resulting in a decline in US corporate earnings. Equities and fixed-income, specifically high yield, felt the hit. But some multi-asset and macro-focused strategies had the ability to minimize or even take advantage of this environment. Why? As many multi-asset portfolios use a macro strategy, changes in the global economic trends are built into evaluation mechanisms. Depending on the risk management components, losses can be mitigated by adjusting asset class exposure—either by reducing exposure to energy equities themselves or to oil and oil-sensitive commodities.
In another dimension within the multi-asset universe, those strategies that are true global macro alternative types can actual short energy, which can offset risk during these times and potentially enhance returns. All that said, despite what the Fed does with interest rates this summer (or next) and how China’s currency is affected by that decision, multi-asset portfolios have additional tools to meet their objectives. With the wide proliferation of ETFs in recent years, implementing multi-asset exposure and tactical approaches to multi-asset allocation has become increasingly more efficient with ETFs.
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Finding the right strategy can complement an overall portfolio and help keep clients on track and disciplined, even when markets get challenging. Of course, there are many approaches to multi-asset portfolio allocation. To separate the wheat from the chaff, it would be wise to query each strategist about the specific inputs and approach that dictates their outcome. For instance, “How did your strategy impact your approach when oil prices dropped?” This type of evaluation can glean insight into how a portfolio responds to asset movements, not just equities, and help you refine your portfolio to more effectively target your clients’ desired outcomes. Once you do, even Janet Yellen will likely envy your ability to ride the tides of global economic change. (Oh, if only a multi-asset portfolio could do the same for the Fed!)