As multi-asset managers look beyond equities and bonds for sources of diversification, many are turning to real assets, such as gold and commodities, and liquid alternatives to de-correlate portfolios.
After equities and fixed income asset classes fell in tandem in 2022, several commentators suggested the traditional 60/40 method of investing had passed its sell-by date. According to Yoram Lustig, head of global investment solutions, EMEA at T. Rowe Price, the traditional 60/40 is not dead but is going through a difficult period.
“As 2022 demonstrated, during an inflationary shock, equities and fixed income become positively correlated, leaving portfolios under-diversified,” he said.
Lustig structures T. Rowe Price’s multi-asset portfolios into buckets, with allocations tailored to client risk appetites.
“Equity exposure is the strategic cornerstone and the largest risk exposure in most multi-asset portfolios, while the defensive fixed income position – which includes high-quality, long-duration bonds – provides protection against equity downside,” he said.
“While the mid-risk bucket, comprising of high yield and emerging market debt, provides additional return sources and helps to boost income, it does not diversify equity risk, given the high correlation with equities.”
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Within fixed income, Lustig argued gilts alone cannot be relied upon by UK investors to diversify equity risk, which is why he said a global approach – including US treasuries, Japanese government bonds, and German bunds – is essential.
“The mini‑budget of October 2022 is also a perfect example of how going global can help to mitigate country-specific shocks,” he said. “In addition, the dollar has retained its safe-haven status, as evidenced by its appreciation when the war in Iran broke out, so it may also be beneficial to maintain unhedged dollar exposure at times.”
Outside traditional asset classes, Lustig allocates to defensive liquid alternatives with low correlation to equities. “This component has become increasingly important in recent years, as bonds have failed to play the historical risk-balancing role,” he said.
Deliberate diversification
For Patrick Brenner, global head of multi-asset investments at Schroders, periods of geopolitical and macro uncertainty, such as the latest events in the Middle East, reinforce a core multi-asset principle: namely, “diversification must be deliberate and forward-looking”.
“Building portfolios with inherent hedges – including measured exposure to commodities and avoiding excessive concentration in any single sector – can materially improve resilience,” Brenner said.
“When portfolios are structured proactively, investors are often in the more advantageous position of deciding where to take profits during market stress, rather than being forced to reactively cut losses.”
In recent years, Brenner noted traditional assumptions have been tested. “Bonds have not always behaved as reliable diversifiers, particularly during inflation shocks, and the long-standing strength of the dollar has periodically come into question,” he said.
In this environment, he argued incorporating real assets such as gold and broader commodities can play an important stabilising role.
“These exposures can provide diversification benefits when markets reprice and can help portfolios navigate supply-driven shocks or renewed inflation volatility,” he said.
“Thoughtful allocation to real assets therefore strengthens overall portfolio robustness when traditional hedges prove less dependable.”
Positive sentiment
Jeffrey Palma, head of multi-asset solutions at Cohen & Steers, echoes the positive sentiment towards real assets.
“Real assets remain one of the most compelling investment opportunities in the decade ahead, supported by structural macroeconomic tailwinds, attractive valuations and strong income characteristics,” he said.
“In an environment defined by inflation variability, scarcity of physical inputs and elevated geopolitical risk, real assets offer diversification benefits that are difficult to replicate.”
As a result of the “robust performance” of US equities, Palma said valuations are now at near historical extremes. However, he added the underlying reality is more “nuanced”.
“While technology-led growth is real, the cost of capital has structurally risen, input prices remain firm, and margins are now more likely to compress than expand,” he said. “This is why the case for rotation away from narrow US equity leadership and towards more attractively valued, more diversifying assets is stronger today than at any time since the early 2000s.”
This, for Palma, is where real assets, in particular, stand out. “Their combination of appealing valuations, strong inflation linkage, healthy fundamentals in supply-constrained segments, and positive correlation with the themes of the new regime, positions them for a larger role in long-term portfolios,” he said.
“Infrastructure and natural resource equities benefit from multi-year investment cycles and supply discipline; commodities have experienced years of underinvestment; and listed real estate, having reset meaningfully, offers more balanced return prospects with improved income yields.”
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Claus Vorm, deputy head of the multi assets team at Nordea Asset Management, said that for more than a decade after the financial crisis in 2008, most multi-asset approaches – including the 60/40 – largely delivered on their long-term return objectives, as traditional asset classes performed in unison.
“The need for portfolio diversification was only infrequently put to the test,” he said. “However, as turmoil swept through markets in 2022, traditional diversification methods were regrettably found wanting.
“Historically, fixed income has been the investor instrument of choice to mitigate equity market downside. But many investors were left with nowhere to turn when both stocks and bonds sold off aggressively in tandem. This has happened on multiple occasions in recent years.”
Nordea has a differentiated approach to portfolio construction, Vorm adds: “In our view, traditional diversification has, for some time, been unable to protect investors as much as it used to. As such, investors can adopt differentiated approaches to risk balancing, such as opportunities in alternative risk premia.
“We believe investors can capitalise on both cyclical and anti-cyclical return drivers through a broad, diversified set of risk premia spanning strategy types and liquid asset classes.”
