2024 has been a year rich in noteworthy events for investors. Elections in the UK, France and the US, the beginning of rate cuts across developed markets, and geopolitics have dominated headlines, causing volatility in prices across different asset classes.
As always, one of the main challenges is to separate the noise from the valuable information and 2024 is an interesting example of how people can get too focused on what is unlikely to be a driver of long term portfolio returns, as elections and locally contained geopolitical tensions are unlikely to change the long term path of the world economy.
Investors paying attention to key global events, display a strong interest in how they can improve their portfolios to ensure they are robust and adaptable to different market environments. In this regard, the debate between the use of active versus passive continues to be a prominent topic of conversation.
Elections
The election of Donald Trump has brought animal spirits back into the market, with the S&P500 reaching new peaks and, particularly, smaller companies and financials rallying on the back of expectations of tax cuts and a new wave of aggressive deregulation. At the same time, credit spreads have tightened, improving financial conditions for companies.
Nonetheless, the situation is more complex than that with rosier expectations prompting investors to question whether FED cuts will be enacted at a quick pace, and whether Trump’s widely expected trade policy will cause inflation to return.
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Some investors are also starting to show some nervousness around the path of the budget deficit, which could add to inflationary pressures and increase bond yields.
As is always the case, positioning your portfolio for a binary event such as an election is risky as it can expose portfolios to unintended outcomes. As history shows, over the long term, it does not seem to matter whether one party or the other is in power: staying invested with well diversified portfolios has always been the most rewarding choice.
Therefore, focusing on fundamentals and avoidance of portfolio concentration are key to navigating elections more smoothly and without affecting long term outcomes.
Geopolitics
As tensions around the globe continue without an end in sight, many investors fear that further military escalations may cause geopolitical risks to spill over to global financial markets. This could in turn affect commodity prices, depress equity prices and potentially bring back inflation.
Although we should never underestimate geopolitical risk and its implications for financial markets, the good news is that multi-asset investors have many tools to mitigate these risks.
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Assets doing well in ‘flight-to-quality’ environments, such as safe haven currencies or high-quality government bonds, might mitigate portfolio risk as global tensions heat up. In case of inflationary pressures, exposure to assets with sensitivity to inflation, such as energy stocks and inflation-linked bonds, can improve portfolio robustness.
Consequently, the best response to geopolitical risk is to stay diversified, and to avoid portfolio concentration and assets particularly exposed to the sources of geopolitical concerns, as opposed to trying to predict and position your portfolio for a single outcome, which may lead to unfavorable outcomes if events do not turn out as expected.
Active vs passive
The choice of active versus passive always sparks an intense debate from both sides. The reality is that both active and passive have a role in investors’ portfolios, and they may serve different purposes.
The concentration of market indexes and the good performance of passives should not make us forget that the more extreme the concentration becomes, the more active management has the chance of finding attractive opportunities and generating attractive risk-adjusted returns over the long term.
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Active managers also have the ability to exploit market inefficiencies and get exposure to specific factors that can help in different market environments, thereby improving diversification. Although there is not a silver bullet for selecting the best active managers, the first thing to consider is price – overpaying for a performance that tracks closely that of the index may not be a great idea.
On the other hand, a manager with an acceptable tracking error and a high active share, might provide a good compromise between maintaining a balanced risk profile and the likelihood of generating alpha through stock selection.
Therefore, even though the choice of an active manager is more complex, this might pay off over the long term through superior risk-adjusted returns. Investors should not have an ideological approach to such a debate and need to make sure that implementation is consistent with their objective.
Nicolo Bragazza is a portfolio manager at Morningstar Wealth
This story was written by our sister title, Portfolio Adviser
