Reimagining multi-asset
How can investors remain at the forefront of innovation and ensure true diversfication in 2025?
present
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Against a backdrop of elevated volatility, Newton head of mixed assets investment Paul Flood outlines the multi-asset team’s latest thoughts on bonds, equities and alternatives.
Current multi-asset positioning
Throughout 2024, a rapid and welcome fall in inflation inspired hope that the pricy post-pandemic days were behind us. However with several inflationary factors converging, investors risk underestimating long-term inflation risks, leaving their portfolios vulnerable.
Inflation: on track or off course?
In what ways has the world changed since the end of the pandemic? Will those changes continue? And what implications does regime change have for multi-asset investors?
What investors need to know about the 'new regime' for multi-asset investing
Interest rates are likely to continue into this year. So, when staying in cash is an attractive option, why should clients consider taking on investment risk? Quilter Investors answer this question and explore the impact of the US election and the Labour Budget on investors.
Do higher-for-longer interest rates weaken the case for investing?
Latest insights
How can investors remain at the forefront of innovation and ensure true diversification in 2025?
Previous insights
We asked our four sponsors for their views on what a new government could mean for fixed income and the gilts market
Election special
Latest line - 828
Embracing flexibility in strategic bonds
ARTEMIS
Active opportunity springs from blooming yields
QUILTER INVESTORS
Absolute return bond funds: Game over?
ORBIS
With rate cuts on the horizon, where next for cash investors?
BNY INVESTMENTS
Artemis
What’s the difference between a fund of funds (FoF) and a managed portfolio service (MPS) – and which is right for your client? Quilter Investors explore each investment solution’s unique characteristics and their different uses in financial planning.
Navigating multi-asset investing: Fund of funds vs managed portfolio services
Multi-asset investors can enjoy attractive returns without placing a concentrated bet on mega-cap growth stocks in the US.
Looking for diversity? Look beyond the US and tech stocks
Newton portfolio manager Janice Kim assesses some of the key macroeconomic themes she thinks could influence multi-asset investors’ decision making in the year ahead.
Four macro themes for multi-asset investors
Although the classic portfolio of 60% equities and 40% bonds has delivered a terrific balance of risk and return for investors in recent decades, Orbis believe its future prospects appear far less promising. In the face of shifting market dynamics investors need to adjust their expectations or their portfolios.
Why 60/40 no longer fits the bill
The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed. Important information For Professional Clients only. This is a financial promotion.
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes.
Sources 1. FCA.org.uk. Reforms to financial services retail-disclosure requirements. 19 September 2024.
For further information visit bnymellonim.com
“Equity valuations remain elevated, but we are seeing earnings growth broaden out across the market”
10-year government yields – US, UK
Source: Bloomberg, 8 November 2024.
US 10-year treasury yield
UK 10-year gilt yield
MSCI World earnings per share expectations (US$)
Source: FactSet, IBES consensus, 30 September 2024. P/E – Price to Earnings.
2022
2023
2024
9%
Paul Flood, Head of Mixed Assets Investment
CONTRIBUTOR
At the beginning of 2024 we felt a lot of rate cuts were being priced into the market, so we reduced the allocation to bonds. During the growth scare we saw in August 2024, when equity markets sold off, we saw good returns from the bond market. In terms of current market observations, since the US presidential election, yields on the 10-year US Treasury and 10-year gilt have been moving towards 5%. This is likely because the market has priced in inflationary concerns arising from both government fiscal spending and some of the Trump policies. Since the end of Q3 2024, we have been adding back into the bond market at the longer end where we're getting up to 5% particularly in the UK gilt market. We think 5% sounds reasonable, given where inflation is. If the central banks are successful at keeping inflation at target, that could lead to a 3% real return which we believe is attractive.
Bonds
Equity market valuations are elevated. In fact, valuations are in similar territory to early 2022, driven by growth stocks, particularly the ‘magnificent seven’ group of technology companies. Looking back, we reduced equities going into 2022 and increased that going into 2023. More recently, however, we've been conscious of valuations. So, while equity weightings haven't changed dramatically, we have made reductions to our technology exposure, given how strong this sector has been.
Increased concentration within indices and equity portfolios is something the team is concerned about, but we have been observing earnings numbers starting to grow across the broader market. One area of opportunity we see in equities is stemming from the manufacturing renaissance, particularly in the US. The boom in artificial intelligence and the related increase in data centres and areas like cloud computing are likely to create significant demand for electricity.
Equities
The alternatives space has seen weakness of late. This can be explained, in part, because higher interest rates have resulted in greater demand for bonds, so competition for investors’ capital has been fierce. Other contributors to weakness have included the debate around cost disclosure for investment trusts, as well as pension funds selling risk assets as they offload balance sheet risk to match liabilities. We reallocated some of the alternatives’ exposure through 2022 and 2023 into the bond allocations within portfolios. But we are now more optimistic on alternatives. One reason for this is financial services retail disclosure requirements are being reformed . We think this could entice multi-asset investors back into the investment trust space. Another reason for optimism is the inflation-linked nature of some renewables. With concern around inflation remaining higher, the inflation-linked cash flows characteristic of the renewables space could be positive for investors, providing portfolio diversification against bonds and equities.
Alternatives
The Newton multi-asset team has been adding to bonds across portfolios on the belief they provide diversification. Meanwhile, equity valuations remain elevated, but we are seeing earnings growth broaden out across the market. Elsewhere, we are optimistic on certain alternatives.
1
RETURN TO HOMEPAGE
The value of investments can fall. Investors may not get back the amount invested. Important information For Professional Clients only. This is a financial promotion.
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For further information visit http://www.bnymellonim.com.
US fiscal deficit (% of GDP)
Source: CBO ‘The Budget and Economic Outlook: 2024 to 2034’, June 2024 (CBO projection from 2024).
US implied overnight rate & number of hikes/cuts
Source: Bloomberg (WIRP - World Interest Rate Probabilities), 6 November 2024.
Number of hikes/cuts priced in
Implied policy rate (%)
“Combined with other dynamics like ageing demographics and the rising costs of healthcare, and higher debt, investors have called into question whether government spending is sustainable”
One theme emerging in this new regime is increasing state involvement in economies. This is evident in the US and other nations through larger fiscal deficits (see chart below) and rising government debt to GDP levels. This is likely to continue given some of the structural shifts underway like deglobalisation and reshoring. Combined with other dynamics like ageing demographics and the rising costs of healthcare, and higher debt, investors have called into question whether government spending is sustainable.
But can economies grow their way out of their debt situations without inflation spiralling? In the US, prices have cooled and despite higher interest rates the economy and labour market have been reasonably resilient. That said, new US job additions have been declining, leading to a debate around growth versus inflation and where interest rates are likely to go from here.
Big government
The market’s expectation on interest rate cuts has lowered. In summer 2024 nearly seven cuts were being priced in. Today, the market is pricing in four cuts over the next five quarters, which would leave the policy rate at about 3.8% by the end of 2025 (see chart below).
But investors are divided on the path for interest rates. One side argues growth has been resilient in a higher rate environment. Therefore, slow moderate cuts would ensure the inflation genie is put back in its bottle. On the other side, however, people expect more aggressive rate cuts to pre-empt any sort of severe recession now that we've seen evidence of a slowing labour market in the US. We expect this tug of war to continue with the markets remaining focused on employment data.
Interest rate ‘tug of war’
Following Donald Trump’s election victory, the market's focus has shifted from political uncertainty to policy uncertainty. Key themes for Trump's second term appear to be tariffs, immigration, deregulation, and lower taxes and fiscal spending. The Republicans may be able to advance Trump's agenda more easily with the House and the Senate both under Republican control. In the UK, the Labour Party’s budget in October 2024 delivered an increase of around £40bn in taxes . Businesses are set to do the heavy lifting on this, with higher National Insurance (NI) contributions expected to bring in the bulk of that total . This additional NI burden may end up being a drag on economic growth if businesses look to cap wage growth and limit hiring and investment, especially employers of lower paid workers. The UK government also announced current (day-to-day) spending is projected to rise by £47bn (1.4% of GDP) by 2029/30 . The discrepancy between expected tax revenues and spending has meant higher borrowing, all at a point when borrowing costs are high. The UK faces similar issues around fiscal deficits and government debt levels as the US. But we are seeing divergent policies between the UK and US economies. The Trump administration appears to be laying plans to reduce public spending and maintain lower taxes, while the UK is effectively doing the opposite. These divergent policies could potentially lead to very different longer-term outcomes in growth and inflation for the UK and the US.
Political moves
Growth has also been a challenge for China, the world’s second-largest economy. While the Chinese government’s economic stimulus measures have revived hopes of a consumption recovery, the question remains as to whether the government can, in fact, jumpstart the economy back into growth mode. The China market trades at around 10 times earnings . This makes valuations for certain quality Chinese companies looking compelling, even in the absence of any government stimulus.
China
For a long time, investors were used to an environment led by monetary policy, globalisation and free trade, low to zero interest rates and disinflation. But the world is now dominated by fiscal measures, increased protectionism, deglobalisation and reshoring, higher debt costs, and potentially higher inflation. We ask ourselves whether this paradigm shift will drive a return to cyclicality and increased volatility. As multi-asset investors, we view volatility as our friend. It allows us to take advantage of market dislocations across asset classes and find attractive entry points for areas of long-term opportunity.
Sources 1. Guardian. Budget 2024: Reeves reveals £40bn in tax rises as she promises to rebuild public services. 30 October 2024. 2. Financial Times. Businesses and wealthy bear brunt of £40bn tax increases in UK Budget. 30 October 2024. 3. Capital Economics. Despite large rise in taxes, Budget still boosts economy. 30 October 2024 4. Bloomberg data, as at 29 November 2024. On a forward-looking price-to-earnings (P/E) basis, based on the MSCI China Index.
2
3
4
Janice Kim, Portfolio Manager
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any statements are based on Artemis' current opinions and are subject to change without notice. They are not intended to provide investment advice and should not be construed as a recommendation Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.
Find out more about the Artemis Monthly Distribution Fund
“In bond markets, the explosion in debt-to-GDP ratios across much of the world may suggest that it would be imprudent to take a 'buy-and-hold' approach to government bonds, particularly at the long end of the curve”
Quantitative easing (QE) Worries about deflation Austerity Long-duration government bonds Globalisation Peace Capital-light platforms Profitless growth Just-in-time supply chains
Then...
Now...
Quantitative tightening (QT) Uncertainty about inflation Debt-to-GDP >1OOo/o Short-dated corporate bonds Nearshoring / autarky War Capital-intensive industries Dividend yields Just-in-case inventory
Jacob de Tusch-Lec, Co-Fund Manager, Artemis Monthly Distribution Fund
Our expectation is that the world described in the left-hand column of our table will continue to give way to the one on the right. That process won't, however, always be smooth; it will come in fits and starts. There will be reversals. In contrast to the decade in which QE artificially suppressed volatility and pushed the valuation of long-duration assets steadily higher, its withdrawal seems likely to provoke it. In bond markets, the explosion in debt-to-GDP ratios across much of the world may suggest that it would be imprudent to take a 'buy-and-hold' approach to government bonds, particularly at the long end of the curve. In equity markets, investors will need to be nimble and be prepared to take short-term tactical positions that may be at odds with the long-term direction of travel. The new regime may not necessarily be an environment in which it pays for multi-asset investors to run their winners - but instead to be active and agile. That suits us.
In the new regime, we are not expecting to 'buy and hold'
If you've attended one of our presentations or webinars over the past few years, you'll have heard us explaining why we believe the world is in the middle of a process of 'regime change' of the type only seen once every few decades. You'll probably also have seen a version of the table below. It contrasts the winners of the decade that followed the global financial crisis with the beneficiaries of the new political, economic and financial regime. We initially drew it up to help clarify our thinking about the big picture for equity markets but it also carries important implications for multi-asset investors.
When we first drew up this table, quantitative easing (QE) was still holding down long-dated bond yields, Russia had yet to begin dropping missiles on Kiev and interest rates across the West were close to zero. At that time, our preference for owning the shares of defence contractors, banks and companies controlling tangible assets in the 'real world' looked out of step with a broader market fixated on long-duration growth stocks with intangible assets. The dramatic sell-off in bond markets in 2022, however, marked a watershed: the end of the pre-pandemic monetary regime. Russia's wholesale invasion of Ukraine, meanwhile, gave vivid expression to the world's ongoing descent into a less stable geopolitical era. And now?
As the world has become less peaceful, defence stocks have performed incredibly well. The rise of political populism (itself a reaction to the rising inequality that a decade of QE fuelled) has seen decades of globalisation being replaced by nationalism and the onshoring of strategically important industries. Building and powering Al data centres - and incorporating renewables - has propelled demand for semiconductors, smart power grids and nuclear reactors. With interest rates and bond yields having moved meaningfully higher relative to their pre-pandemic levels, the profitability of banks and insurers has been transformed.
• • • •
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Reference to specific shares or companies should not be taken as advice or a recommendation to invest in them. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any statements are based on Artemis' current opinions and are subject to change without notice. They are not intended to provide investment advice and should not be construed as a recommendation. Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.
“The depth and diversity of the world's equity markets should make them a core hunting ground for multi-asset investors”
Apple Nvidia Microsoft Amazon Meta Tesla Alphabet (A) Alphabet (C) TSMC Broadcom Total
4.54 4.27 3.76 2.47 1.58 1.25 1.25 1.08 0.95 0.91 22.05
32x 33x 30x 36x 23x 126x 21x 21x 18x 36x
Top 10 constituents MSCI AC World Index
Proportion of index (%)
12-month forward p/e
Source: MSCI, LSEG Datastream as at 31 December 2024
One result is that US stocks now account for almost 70% of the global equity market by value (up from around 40% in 2008) . You might reasonably argue that doesn't matter: America's technology giants are, in reality, global - rather than local - businesses. Of potentially greater concern, however, is that the 10 largest stocks by weight in global index today appear to be thematically linked.
A narrow group of companies and investment themes have progressively come to dominate global indices
To varying degrees, the lofty valuation multiples of all of these businesses are being supported by the assumption that generative Al has permanently transformed their earnings potential. The problem, however, is that if you allocate your capital to these businesses in anything approaching their index weightings (together, these 10 stocks account for around a quarter of the MSCI AC World Index) you will have assembled a lopsided portfolio whose returns are skewed towards one type of business. If your equity portfolio resembles the index, you're taking a significant bet on technology, on US growth stocks and on Al. That bet might pay off- but it should not be mistaken for genuine diversification. Given the narrowness of markets, investors may be at risk of over-allocating to a small group of stocks while simultaneously under-allocating to other potential sources of return.
The good news is that exposing your equity portfolio to a variety of future cashflows has not necessarily meant sacrificing returns in the near term; it is possible to harvest attractive returns from global equities without placing an outsized wager on US mega-cap growth stocks. In 2024, for example, investors could have enjoyed market-beating returns by investing in dividend-paying (and reasonably valued) stocks in such diverse areas as:
The depth and diversity of the world's equity markets should make them a core hunting ground for multi-asset investors. But before you commit too much of your financial future to a narrow group of the most widely held (and often expensive) stocks, consider taking a wider view - and looking beyond the usual suspects.
There are other (profitable) themes and sectors to follow
Investors in multi-asset funds will be familiar with the power of diversification, 'the only free lunch in investing'. Spreading your risk across a variety of assets with different characteristics in a range of political and economic regimes - giving your portfolio exposure to a spread of future cashflows - provides valuable insurance against the unexpected. Yet while most multi-asset funds deliver instant diversification on an asset-class level, the increasingly concentrated nature of capitalisation-weighted stockmarket indices suggests that investors may need to look beyond 'the usual suspects' if they are to reap the benefits of diversification on a company level.
Sources 1. American stocks are consuming global markets 2. All returns: LSEG Datastream as at 31 December 2024
Over the past decade, a handful of interrelated themes have characterised global markets:
The outperformance of US equities. Hopes that generative Al will permanently transform the earnings potential of a group large, technology companies. The outperformance of 'growth' stocks relative to their 'value' counterparts.
• • •
Gold miners (In sterling terms, Canada's Kinross Gold returned 59% in 2024). Enablers of the energy transition (Germany's Siemens Energy returned 299%). Banks and insurers (South Korea's KB Financial returned 43%). Engineers (Japan's Mitsubishi Heavy Industries returned 149%). Defence contractors (Germany's Rheinmetall returned 106%) .
• • • • •
James Davidson, Co-Fund Manager, Artemis Monthly Distribution Fund
Important information For Professional Clients only and not to be distributed to or relied upon by retail clients. Past performance is not a guide to future performance. Opinions and examples represent our understanding of markets: they are not investment recommendations advice. All data is sourced to Aegon Asset Management UK plc unless otherwise stated. The document is accurate at the time of writing but is subject to change without notice. Data attributed to a third party is proprietary to that third party and is used by Aegon Asset Management under licence. Aegon Asset Management UK plc is authorised and regulated by the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025
Sources 1. www.statista.com 2. What worked (and didn’t work) during 1970s stagflation 3. Investing during Stagflation: What happened in the 1970s 4. www.bankofengland.co.uk 5. www.sipri.org
Learn more about Orbis Investment Management
“We may be unlikely to return to the exceptional inflation rates of the recent past; however given the damage that persistent inflation has wreaked upon bond and equity markets in the past, investors would be wise to keep their guards up”
XXXXXX
Source: 31 Dec 2023. Indicative estimates only. Forecasts are inherently limited and cannot be relied upon. Source: International Monetary Fund, World Bank, International Energy Agency, Lazard, US Bureau of Labor Statistics, Eurostat, UK Office for National Statistics, Japan Ministry of Internal Affairs and Communications, Japan Ministry of Health, Labour, and Welfare, LSEG Datastream, Orbis. GFC is the 2008-2009 global financial crisis. Inflation for advanced economies, proxied by the US, European Union, UK, and Japan, weighted by GDP at current USD levels.
Structural forces could drive higher long-term inflation
Potential contribution to consumer price inflation, advanced economies
Our electric grids are aging and need replacing
Average age of global electricity cable and other grid infrastructure
Inflation (CPI)
Cash ISA rate
40
35
30
25
20
15
10
5
0
Europe
North America
Latin America
South East Asia
Rest of Asia
Middle East
Africa
Design life of grid infrastructure:
30 years
Source: 31 Jul 2024, Nexans.
After the Covid lockdowns at the start of the decade, the global economy recovered at a startling pace. In the UK, social-distancing mandates were lifted in mid-July 2021, and by March 2022 unemployment rates had fallen to pre-pandemic levels. Stimulus measures enacted to keep economies afloat – like furlough schemes in the UK and government-issued cheques in the US – meant many businesses had money for hiring once the services and hospitality industries reopened. The rise of hybrid working also gave skilled workers the ability to look further afield for well-paid jobs, pushing wages higher as companies competed for the best employees. Ageing demographics have been upping labour costs too; the retirement of the outsized Baby Boomer generation means more jobs for fewer workers, which increases wage competition.
Increased labour power is influencing wage growth
...from a globalisation perspective, at least. If trade in the 20th century was defined by nations coming together, the 21st century has to be defined by much more protectionist policies. This trend came to prominence in 2016 with the UK’s Brexit vote and Trump’s first presidential victory. But it has since become resurgent, with geopolitical tensions leading to higher shipping costs and greater ‘onshoring’ of supply chains; renewed protectionism in India; populist gains in the European Parliament and EU tariffs on Chinese vehicles; and now Trump’s re-election. While the aim of less dependence on outside nations is to keep financial successes close to home, protectionist policies can lead to inflation. Supply chains get jammed up or entail high taxes on materials imported from abroad. Businesses then pass these expenses on to consumers in the form of higher prices. And with less international competition, domestic producers can raise their prices.
The world is getting smaller...
Even worthy causes come with costs. In the coming years, countries and companies around the world will be looking to update their energy infrastructure, either out of necessity or from a desire to go greener as global temperatures rise. The chart below shows that almost all regions of the world are fast approaching the 30-year mark that indicates the need for upgrades. Europe and North America, two regions whose monetary policies tend to have knock-on effects for the rest of the world, both passed that threshold a good few years ago.
These upgrades will come with significant up-front costs, which means energy prices will rise as businesses pass these expenses onto consumers.
The price of prioritising energy infrastructure
Ongoing strife in the Middle East and Europe is prompting governments to increase defense spending. In October 2024, the UK announced a nearly £3 billion increase in defense spending for 2025, both for the domestic military and as part of a commitment to NATO. Poland, Italy, Germany and Sweden have all increased their defense budgets too, especially given their proximity to the war in Ukraine. And the US’s defense spending accounted for 68% of NATO’s total military expenditure in 2023. Meanwhile, President Elect Donald Trump is calling for NATO countries to spend at least 5% of GDP on defense when many still aren't at 2%! Geopolitical conflict is leading to higher demand for everything from weapons and vehicles to new military bases. This, along with plumped-up wages for military personnel, also contributes to inflation.
All in all, we seem to be exiting the era of ‘easy money’ that persisted for the better part of 20 years. The evidence points to higher long-term inflation, this time paired with still-high interest rates. And as the economic backdrop changes, so must our manner of investing. In a world with increased defense spending, costly commitments to an evolving energy system and demographically driven wage growth, higher inflation will present significant challenges for traditional 60/40 investment portfolios. Expensive valuations for stocks and lacklustre bond yields suggest the need for deeper diversification across assets and geographies as the sun begins to set on the benign environment of the last 10 years.
Defense spending for an uncertain world
In recent months, investors have taken heart from the fall in inflation around the world towards central banks’ target levels. At first glance, the pain of rate hikes appears to have paid off, with subdued inflation providing gains, prompting central banks to start cutting rates again. But beneath the surface, the structural drivers of long-term inflation are still very much in place. These include increased labour power, a retreat from globalisation, the energy transition and the need for higher defense spending. These inflationary pressures are compounded by shorter-term developments too: Donald Trump’s election victory on the promise of higher tariffs on imports and tax cuts for American businesses; the UK’s expansive Autumn Budget; and political victories for populists and protectionists around the globe. So the bright new dawn of falling inflation may prove short-lived; even in September 2024, the month in which UK inflation fell below that long-desired 2% threshold, more than half (52%) of British households reported that their cost of living had risen in the past month. We may be unlikely to return to the exceptional inflation rates of the recent past; however given the damage that persistent inflation has wreaked upon bond and equity markets in the past, investors would be wise to keep their guards up.
2,3
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Post-GFC average
Labour power
End of globalisation
Energy transition
Defense spending
Potential structural inflation
2, 3
“The 60/40 doesn’t always work. In certain economic conditions, its effectiveness diminishes markedly”
Stockmarket valuation percentile for 12 long-term measures, plotted from 1970
On a range of metrics, stockmarkets have rarely been more expensive
Source: 31 Aug 2024. Robert Shiller, Kenneth French, World Bank, International Monetary Fund, LSEG Datastream, LSEG Worldscope Fundamentals, Orbis. Percentiles calculated over the full history for each measure. US measures included with dotted lines when they significantly extend the history. Cyclically-adjusted price-earnings ratio uses the average of ten years of inflation-adjusted earnings. US equity risk premium is the cyclically-adjusted earnings to price of equities minus the yield on a 10-year US Treasury note. World equity risk premium is the trailing earnings to price of developed stockmarkets minus a blend of 10-year bond yields for the US (50%), Europe (35%), and Japan (15%). World market cap to GDP calculated using the market capitalisation of developed stockmarkets and the gross domestic product in current USD of high-income countries. Enterprise value measures for developed market non-financial companies. EBITDA is earnings before interest, tax, depreciation, and amortisation.
Contribution to market value and profit* of MSCI World Index
‘Magnificent 7’ versus the ‘Mundane 7’: similar market value, a third of the profits
Magnificent Seven
Mundane Seven
12% of profits
32% of profits
Japan
United Kingdom
Canada
France
Switzerland
Germany
Australia
Apple
Microsoft
NVIDIA
Alphabet
Amazon.com
Meta
Tesla
10-year subsequent real annualised return of a US 60/40 portfolio
The 60/40 has generated excellent real returns recently - but not always
+8%
p.a real returns through 2021
-3%
p.a real returns for a decade
Source: 30 Nov 2024. Robert Shiller, Orbis. 60% S&P 500, 40% 10-year US Treasury.
Source: 30 Sep 2024. MSCI, Orbis. *Represents contribution to MSCI World Index consensus net income estimates for the current fiscal year.
Although the classic portfolio of 60% equities and 40% bonds has delivered a terrific balance of risk and return for investors in recent decades, we believe its future prospects appear far less promising. In the face of shifting market dynamics investors need to adjust their expectations or their portfolios.
There are two main scenarios in which the 60/40 breaks down. The first is when inflation is high. When inflation rises meaningfully above 3%, bonds and equities tend to move in tandem – with inflation curbing the performance of both. Higher inflation and interest rates drive down the prices of bonds already in circulation. Today, rates may be starting to fall, but they’re unlikely to return to the historically low levels of recent years, meaning that bond prices won’t receive the same sort of boost. At the same time, companies face higher input costs and spiralling wage costs, which they may not be able to pass on to customers. And higher prices can cause consumers to reign in their spending. All of that can lead to lower corporate earnings and, consequently, lower stock prices. The second scenario is when economic growth is constrained. When the economy stagnates, so do corporate profits. This tends to depress the stock market. Sluggish growth usually entails lower yields from government bonds. This means that the income available from bonds is unlikely to offset any weakness in equities.
When 60/40 won’t do
While inflation has recently fallen back towards central banks’ targets, it remains high in many economies, with political developments posing the risk of renewed upward pressure. These include Donald Trump’s victory in the US presidential election, with his promise of sweeping trade tariffs; the high-spending budgets announced in the UK and Europe; and the need for greater spending on energy and defence. Meanwhile, growth is lacklustre in many countries outside the US. For investors, this undermines the attractions of the 60/40 model. It also leaves the prospects for future returns looking relatively bleak. After a very strong run, equity markets, particularly in the US, look fully valued. Meanwhile, bond yields are relatively modest. So the returns on offer from a 60/40 approach look distinctly unappealing.
A cautious outlook
But that’s not all. Market concentration poses additional risks. Just 15 years ago, the US accounted for around 50% of the MSCI World index, with the tech sector making up around 10%. Today, those figures are around 74% and 26%, respectively. And this concentration is even narrower than those numbers would suggest. In recent years, equity markets have been led up by the surge in mega-cap US technology stocks – most notably the ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla). As a result, a hefty chunk of global market capitalisation is concentrated in a very few companies: today, the Magnificent Seven represent around 20% of passive global portfolios. So any downturn in their fortunes could have massive consequences for markets at large, and in particular to passive investors who are increasingly exposed to the fortunes of these companies.
The perils of concentration
Lofty valuations pose a further acute risk. Valuations in the market-leading sectors look very full – close to their highest levels since the bursting of the dotcom bubble. If anything alarms investors, these are the sectors most prone to profit-taking and panic selling. If passive funds join in the selling, their biggest sales will be their biggest holdings—the very stocks that led the market over the past decade.
So what should investors do? In our view, they should adjust both their expectations and their portfolios. Rather than leaning on a strategy best suited to the past few decades, investors should consider what will work from today’s starting point. With bond yields middling, equity valuations stretched, and inflation risks rising, the classic 60/40 seems unlikely to repeat its past success. To prepare, investors should aim for true diversification - within asset classes, across asset classes and across investment styles. To achieve genuine diversification, investors should look at active equity approaches– especially those that focus on valuations at a time when the market leaders teeter on precipitous multiples. In an era of tech-fuelled growth, value-oriented stocks have fallen out of of favour, creating a wealth of discounted opportunities for bottom-up, active investors. Investors should also consider inflation-linked bonds, which provide real (i.e. inflation-protected) returns, and corporate bonds, assessed on the same active basis as equities. They can turn to ‘alternatives’ too, including infrastructure assets, which offer relatively inflation-proof cashflows, and gold, which has historically outperformed during periods of low growth. And across all their exposures, investors should diversify by sector, geography and investment style to avoid concentration risk and achieve a better overall balance of risk and return. As night falls on the simpler age in which the 60/40 served its purpose, conditions now demand a more agile approach.
Prepping portfolios for a less certain world
Diversification used to be simple. The ‘60/40’ portfolio – 60% equities and 40% government bonds, often passively invested – was seen as a solution for all seasons. The idea was that equities powered the portfolio with growth when conditions were clement, with bonds providing a safety net when stock markets soured. And historically, the 60/40 portfolio has worked very well. In particular, it prospered over the first two decades of this century – a period characterised by lower interest rates and inflation, subdued labour costs and an absence of global conflict. Falling bond yields created a golden age for the passive 60/40 portfolio in recent decades, as they’ve supported returns and valuations for both bonds and stocks alike. But the 60/40 doesn’t always work. In certain economic conditions, its effectiveness diminishes markedly.
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World market cap to GDP (from 1973)
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Past performance is not a guide to future performance and may not be repeated. Investment involves risk. The value of investments may go down as well as up and investors may not get back the amount originally invested. Exchange rates may cause the value of overseas investments to rise or fall. www.quilter.com Please be aware that calls and electronic communications may be recorded for monitoring, regulatory, and training purposes and records are available for at least five years. The WealthSelect Managed Portfolio Service is provided by Quilter Investment Platform Limited and Quilter Life & Pensions Limited. Quilter is the trading name of Quilter Investment Platform Limited, which also provides an Individual Savings Account, Junior ISA, and Collective Investment Account, and Quilter Life & Pensions Limited, which also provides a Collective Retirement Account and Collective Investment Bond. Quilter Investment Platform Limited and Quilter Life & Pensions Limited are registered in England and Wales under numbers 1680071 and 4163431, respectively. Quilter Investment Platform Limited is authorised and regulated by the Financial Conduct Authority under number 165359. Quilter Life & Pensions Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority under number 207977. Registered office: Senator House, 85 Queen Victoria Street, London, United Kingdom, EC4V 4AB. Quilter uses all reasonable skill and care in compiling the information in this communication and in ensuring its accuracy, but no assurances or warranties are given. Investors should not rely on the information in this communication when making investment decisions. Nothing in this communication constitutes advice or a personal recommendation. This communication is for information purposes only and is not an offer or solicitation to buy or sell any Quilter portfolio. Data from third parties is included in this communication and those third parties do not accept any liability for errors and omissions. Investors should read the important information provided by the third parties, which can be found at www.quilter.com/third-party-data. Where this communication contains data from third parties, Quilter cannot guarantee the accuracy, reliability or completeness of the third-party data and accepts no responsibility or liability whatsoever in respect of such data.
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“Despite the normalisation of interest rates to their historical averages over the past couple of years, both the re-election of President Trump and Labour’s financial plan in the UK pose a real risk of significantly higher inflation”
The importance of investing for the long term
Source: Quilter Investors, FactSet as at 31 October 2024. Total return, percentage growth over period 31 October 1994 to 31 October 2024. Based on an initial investment of £10,000. Global equities is represented by the MSCI All Country World Index, global bonds is represented by the Bloomberg Global Aggregate (Hedged) Index, and cash is represented by the UK Base Rate. The information provided is for illustrative purposes only and doesn’t represent the past performance of any particular investment. It is not possible to invest directly into an index.
Chart 2: Net return from savings after inflation
Chart 1: Savings vs inflation
Source: Quilter, ONS and Bank of England as at 27 November 2024. Consumer Price Index annual rate (ONS) and monthly interest rate of UK monetary financial institutions sterling cash ISA deposits (Bank of England) over period 1 January 2013 to 1 January 2023.
Global equities
Global bonds
Cash
The re-election of President Donald Trump and the UK government’s financial plan could put upward pressure on inflation and extend the era of higher-for-longer interest rates. For some, this might seem like good news, offering a chance to manage wealth without taking on investment risk. However, over the long term, traditional savings methods like cash do not fare as well as investing.
Until the last couple of years, inflation had been much lower by historical standards partly due to globalisation, which kept price rises suppressed and resulted in only gradual erosion of savings over time. The charts below illustrate how the erosion gap widened significantly, even as savings rates began to increase. The data compares the Consumer Price Index (CPI) with the average cash ISA rate. It shows that although savers benefited from a sharp rise in the interest on their savings, this gain was more than offset by rising prices during the same period, leading to a much larger erosion gap than many probably realised.
Mind the savings gap
There are numerous reasons why your clients choose to invest, with the primary objective often being to achieve growth that outpaces inflation. This goal can typically be met by adopting a long-term investment horizon and diversifying investments across bonds, equities, property, and alternative asset classes. Diversifying across asset classes with low return correlations helps portfolios be more resilient to market shocks and downturns. Diversification also smooths out returns over a long-term investment horizon, helping your clients reach their financial goals. It’s important to remind your clients that all investments carry inherent risks and can experience volatility, with values fluctuating both up and down, and no guarantees of investment return. This emphasises the importance of a long-term perspective. The ability to withstand market fluctuations and not sell investments prematurely can significantly enhance the likelihood of achieving real returns.
Why invest when interest rates are high?
The chart below shows that over the long term, there is an upward trend of returns from equities and bonds, despite the short-term volatility caused by major events. In fact, a £10,000 investment into global equities in 1994 could have grown to be worth £127,835 today. This is nearly three times more than bonds (£46,879) and over five times more than cash (£24,508).
The benefits of long-term investing
Despite the normalisation of interest rates to their historical averages over the past couple of years, both the re-election of President Trump and Labour’s financial plan in the UK pose a real risk of significantly higher inflation. Political decisions can greatly impact prices, asset values, and interest rates. For those willing to invest over the long term, a multi-asset approach can be particularly beneficial. By spreading investments across a diversified range of asset classes, portfolios can become more resilient to market shocks and downturns. This can offer your clients a better outcome than if they relied solely on savings, even when interest rates are higher.
Conclusion
We have witnessed the extraordinary re-election of President Trump to the White House, with the Republican Party achieving a clean sweep by retaining the US Senate and recapturing the House of Representatives. This strong mandate from the US electorate potentially paves the way for President Trump to pursue the bold promises he made during his campaign, which could trigger future price rises. During his election campaign, President Trump promised to extend personal tax cuts for US citizens and further reduce taxes for US companies. Additionally, he has issued stark warnings to the rest of the world about the possibility of raising existing tariffs or introducing new ones, which would significantly increase costs for exporters to US consumers. These policies would likely lead to much higher inflation than the US Federal Reserve’s 2% target, and more importantly, could have a significant impact on future US interest rates and ultimately US corporate earnings. Meanwhile, the new UK government presented their first budget in the autumn, surprising many with an increase in National Insurance contributions for the private sector. This change could have significant consequences. Businesses will face tough choices about whether to absorb this cost and dent their profits or reduce their workforce over time, increasing unemployment. Alternatively, they could dilute future workforce wage rises, or pass this extra cost on to their customers through higher prices, again putting upward pressure on inflation. So, why are both the US election and the Labour Budget important for savers and investors?
The rise of inflation (again)
Simon Durling, Investment Director
“The transparent structure of an MPS allows advisers and their clients to see the full range of underlying funds, providing an additional level of transparency compared to the FoF approach”
In the world of multi-asset investing, two different investment strategies are often at the front of advisers’ minds when selecting an appropriate solution for their clients: fund of funds and managed portfolio services.
*Source: NextWealth Multi-Asset Distribution Dynamics report, June 2024.
The more traditional approach to multi-manager investing is a FoF. This is an investment strategy where a single fund invests in a diversified selection of other funds. A FoF also offers advantages to suitable clients that can be summarised by the three Ts: toolkit, trades, and tax. A FoF can often access a wider investment toolkit than an MPS. They can invest in a broader universe including assets such as exchange-traded funds, investment trusts, and derivatives, which are not typically available in an MPS. This can help maximise returns and manage risk. The ability of a FoF to make changes and execute trades at a moment’s notice is another benefit. This allows them to quickly take advantage of market events and opportunities as they are not reliant on platform technology. Finally, a FoF does not create a capital gains tax event for an investor when rebalancing, whereas rebalancing an MPS can trigger an event if it’s held unwrapped.
Fund of funds and the three Ts
A FoF is ideal for investors seeking a diversified investment approach with potential tax advantages and efficient trading capabilities. It can also be suitable for those who prefer a hands-off investment strategy with professional management of a broad range of assets. Meanwhile, an MPS is often suitable for investors who value transparency and want to see the specific funds in which they are invested. It can offer flexibility and a wide range of options, making it a good choice for those who require a more personalised investment approach. Both structures can be used effectively in financial planning and are popular options with advisers - 79% use both as part of their investment proposition*. Understanding their differences and benefits can help advisers make informed recommendations that align with their clients' financial objectives.
A suitable approach
Both a fund of funds (FoF) and a managed portfolio service (MPS) are multi-asset investment solutions that offer advisers the opportunity to outsource the asset allocation, fund selection, and ongoing management of their clients' investments. However, they both have unique characteristics and uses in financial planning as well as differing significantly in their structure and operation.
An MPS is a range of investment portfolios built as models, with the underlying funds held directly by the investor. The transparent structure of an MPS allows advisers and their clients to see the full range of underlying funds, providing an additional level of transparency compared to the FoF approach. The investor can see each component of their portfolio, enhancing the perceived value of their investment. An MPS can also offer advisers and their clients substantial optionality when it comes to investment suitability. For example, WealthSelect, Quilter’s MPS, consists of 56 different portfolios managed across eight different risk levels that each target a specific range of volatility. Then, depending on the needs and preference of their clients, advisers can choose to invest in a managed, responsible, or sustainable portfolio. There is also a choice of active, blend, or passive investment management styles. The optionality of an MPS is a significant advantage for advisers. This is particularly important in a post-Consumer Duty world where there is an increased focus on advisers being able to demonstrate that the products and services they provide to their clients are tangibly linked to their needs, goals, and preferences. An MPS also allows advisers to outsource the ongoing management of their clients’ portfolios. An MPS will be rebalanced on a regular basis to keep it in line with its investment objectives but can also be rebalanced at any time to adapt to changing market conditions.
The benefits of an MPS
Andrew Miller, Lead Investment Director
Navigating multi-asset investing: Fund of funds vs managed portfolio service
