A diversified approach to
dynamic markets
As investors grapple to manage multi-asset portfolios amid today’s uncertainty, they are prioritising portfolio diversification and income via more traditional assets, according to an exclusive poll by AsianInvestor and S&P Dow Jones Indices (S&P DJI).
Persistent inflation, rising rates and a looming recession are weighing on tactical allocation decisions for many asset owners in the Asia-Pacific region, hampering efforts to plan portfolios for the rest of 2022 and beyond.
In response, investors are prioritising portfolio diversification, cash yield and income, and long-term capital growth for the next six months.
"Investors are prioritising portfolio diversification, cash yield and income, and long-term capital growth for the next six months"
Yet it also creates the next big challenge: identifying the most suitable assets, geographies and investment strategies to achieve these goals — and all while embracing ESG considerations.
Such insights come from a survey of 95 senior investment executives, conducted in May and June 2022 by AsianInvestor, in collaboration with S&P DJI. Respondents included insurance companies, public and private pension funds, sovereign wealth funds, government entities, endowments and family offices, from Hong Kong, Taiwan, Australia, New Zealand, South Korea, Japan, Singapore, Thailand, Malaysia, Indonesia, the Philippines and India.
- Post-Covid, performance over the benchmark is the most important consideration when assessing multi-asset exposure.
- 41% are prioritising geographical diversity to tackle market dynamics.
- A mix of active and index-based strategies appeals most for thematic or multi-asset exposure.
- Developed market equities and G3 bonds will see the greatest inflows over the next six months — while investors will reduce exposure to emerging market (EM) equities, local currency EM bonds and digital assets by more than any other asset.
- Nearly two-thirds (65%) believe renewables and clean energy, along with healthcare and biotech, are the themes that will generate the highest risk-adjusted returns over the next 12 months.
- More standardised and accurate data from external providers is the most likely way to enhance ESG integration in portfolios, followed by better-defined internal ESG investment policies.
The key investment risks of inflation, rates and recession are no surprise given the broader dynamics impacting the macro landscape and redefining financial markets.
Notably, however, only 9% of respondents saw escalating geopolitical tensions as the main factor for concern.
In response, investors in the survey are primarily looking for diversification, with income and long-term capital growth also exerting some influence on allocation decisions over the next six months.
At the same time, sustainability has been relegated to the least important consideration among the options for investors to bolster their portfolios.
Yet tackling inflation across various asset classes is easier said than done for many investors.
The starting point, explains Jason Ye, head of strategy indices for APAC at S&P DJI, is to put it in context, where investors define the specific component of the US Consumer Price Index (CPI) that is relevant to their individual portfolio. “Are they impacted by US housing, global energy, or food?” asks Ye. “Each of these will affect allocation decisions.”
Geographical exposure also matters, given the varying levels of inflation between the developed world and EM, and especially Asia. “The US and some countries in Europe are experiencing above 6% year-over-year changes in CPI, while in Asia, inflation is relatively less severe,” he adds.
Once the inflation benchmark is defined, investors can then map out their tactics. “A common approach with US CPI, for example, is to look at the inflation beta of the asset class, which enables investors to compute the hedge ratio,” Ye explains.
In short, with a diversified portfolio across asset classes, investors can then calculate the expected inflation beta to understand how it will respond to changes in US CPI, or their defined inflation benchmark.
The key investment risks of inflation, rates and recession are no surprise given the broader dynamics impacting the macro landscape and redefining financial markets.
Notably, however, only 9% of respondents saw escalating geopolitical tensions as the main factor for concern.
In response, investors in the survey are primarily looking for diversification, with income and long-term capital growth also exerting some influence on allocation decisions over the next six months.
At the same time, sustainability has been relegated to the least important consideration among the options for investors to bolster their portfolios.
Yet tackling inflation across various asset classes is easier said than done for many investors.
The starting point, explains Jason Ye, head of strategy indices for APAC at S&P DJI, is to put it in context, where investors define the specific component of the US Consumer Price Index (CPI) that is relevant to their individual portfolio. “Are they impacted by US housing, global energy, or food?” asks Ye. “Each of these will affect allocation decisions.”
Geographical exposure also matters, given the varying levels of inflation between the developed world and EM, and especially Asia. “The US and some countries in Europe are experiencing above 6% year-over-year changes in CPI, while in Asia, inflation is relatively less severe,” he adds.
Once the inflation benchmark is defined, investors can then map out their tactics. “A common approach with US CPI, for example, is to look at the inflation beta of the asset class, which enables investors to compute the hedge ratio,” Ye explains.
In short, with a diversified portfolio across asset classes, investors can then calculate the expected inflation beta to understand how it will respond to changes in US CPI, or their defined inflation benchmark.
It is also interesting to see from survey respondents that an overwhelming number of asset owners have increasingly — in a post-Covid world — been looking at performance over the benchmark as their most important criteria when assessing multi-asset exposure.
"Asset owners have increasingly – in a post-Covid world – been looking at performance over the benchmark as their most important criteria when assessing multi-asset exposure"
Track record of the investment strategy also features reasonably high on their wish-list. However, the ESG principles of the fund manager, the type of thematic covered and fee levels are each almost an after-thought for investors, given the findings.
In Ye’s view, while assessing multi-asset exposure, especially performance over the benchmark, it is important to understand an appropriate benchmark that reflects the underlying strategy characteristics.
"While assessing multi-asset exposure... it is important to understand an appropriate benchmark that reflects the underlying strategy characteristics"
Based on these investment goals and criteria, survey responses indicated that flows into developed markets equities and G3 bonds may grow between now and the end of 2022.
On the flipside, EM equities, local currency EM bonds and digital assets have fallen out of favour for the majority of respondents.
Ye also highlights other considerations for investors as S&P DJI launched a multi-asset dynamic inflation strategy index last year.
For example, when assessing the inflation beta of different asset classes, he says a natural strategy might be to overweight inflation-sensitive asset classes like commodities, while underweighting those with low inflation beta, such as equities and bonds.
However, inflation beta changes over time and inflation are clearly not the only factors driving asset prices. Further, there is a trade-off between inflation beta and risk-adjusted returns for investors to consider, so investors need to take care to not sacrifice risk-adjusted portfolio returns. “Even though commodities are generally a good option to hedge inflation, historically they have lower risk-adjusted returns, whereas bonds might have low inflation beta but higher risk-adjusted returns,” says Ye.
In terms of the themes from which respondents expect to generate the highest risk-adjusted returns over the next 12 months, asset owners are almost united in their focus on either renewables and clean energy, or on healthcare and biotech.
These themes outshone most others, including sustainable transport, transformative tech, and lifestyle and society.
Driving these allocation decisions, the majority of respondents believe geographical diversity will be most effective in enabling them to cope with today’s environment in terms of rates, inflation and geopolitics.
Some will also look to either take a thematic or sector-focused approach to managing their multi-asset exposure.
In addition to geographic diversity and long-term capital growth, some other common goals of multi-asset allocation include liability management, volatility control and income generation.
“The index strategies designed around these goals can readjust portfolio positions and allocations to risky assets when market conditions and levels of risk change,” explains Ye.
Meanwhile, as the region’s asset owners look to implement their preferred multi-asset exposure, the survey shows comfort with both active selection and more passive strategies.
However, while some investors view indices as benchmarks, they are in fact no longer just a passive solution and viewing an approach as passive versus active is less and less relevant.
“The difference is more about discretionary versus systematic investment decisions, with most systematic approaches likely able to be implemented through index-based solutions,” explains Ye.
It is also interesting to see from survey respondents that an overwhelming number of asset owners have increasingly — in a post-Covid world — been looking at performance over the benchmark as their most important criteria when assessing multi-asset exposure.
"Asset owners have increasingly – in a post-Covid world – been looking at performance over the benchmark as their most important criteria when assessing multi-asset exposure"
Track record of the investment strategy also features reasonably high on their wish-list. However, the ESG principles of the fund manager, the type of thematic covered and fee levels are each almost an after-thought for investors, given the findings.
In Ye’s view, while assessing multi-asset exposure, especially performance over the benchmark, it is important to understand an appropriate benchmark that reflects the underlying strategy characteristics.
"While assessing multi-asset exposure... it is important to understand an appropriate benchmark that reflects the underlying strategy characteristics"
Based on these investment goals and criteria, survey responses indicated that flows into developed markets equities and G3 bonds may grow between now and the end of 2022.
On the flipside, EM equities, local currency EM bonds and digital assets have fallen out of favour for the majority of respondents.
Ye also highlights other considerations for investors as S&P DJI launched a multi-asset dynamic inflation strategy index last year.
For example, when assessing the inflation beta of different asset classes, he says a natural strategy might be to overweight inflation-sensitive asset classes like commodities, while underweighting those with low inflation beta, such as equities and bonds.
However, inflation beta changes over time and inflation are clearly not the only factors driving asset prices. Further, there is a trade-off between inflation beta and risk-adjusted returns for investors to consider, so investors need to take care to not sacrifice risk-adjusted portfolio returns. “Even though commodities are generally a good option to hedge inflation, historically they have lower risk-adjusted returns, whereas bonds might have low inflation beta but higher risk-adjusted returns,” says Ye.
In terms of the themes from which respondents expect to generate the highest risk-adjusted returns over the next 12 months, asset owners are almost united in their focus on either renewables and clean energy, or on healthcare and biotech.
These themes outshone most others, including sustainable transport, transformative tech, and lifestyle and society.
Driving these allocation decisions, the majority of respondents believe geographical diversity will be most effective in enabling them to cope with today’s environment in terms of rates, inflation and geopolitics.
Some will also look to either taker a thematic or sector-focused approach to managing their multi-asset exposure.
In addition to geographic diversity and long-term capital growth, some other common goals of multi-asset allocation include liability management, volatility control and income generation.
“The index strategies designed around these goals can readjust portfolio positions and allocations to risky assets when market conditions and levels of risk change,” explains Ye.
Meanwhile, as the region’s asset owners look to implement their preferred multi-asset exposure, the survey shows comfort with both active selection and more passive strategies.
However, while some investors view indices as benchmarks, they are in fact no longer just a passive solution and viewing an approach as passive versus active is less and less relevant.
“The difference is more about discretionary versus systematic investment decisions, with most systematic approaches likely able to be implemented through index-based solutions,” explains Ye.
Although the general desire among investors to enhance sustainability within all aspects of the investment process might have become overshadowed by immediate market challenges, the survey highlighted the ongoing ESG journey of the majority of respondents.
Around a third of them are developing an ESG investment policy at the moment, with some having created their own ESG scoring system and others outsourcing to third-party ESG ratings providers to inform their strategy.
Further, based on respondents, 15% of asset owners in Asia-Pacific do not have a clearly stated ESG strategy.
To make the role of ESG — and its integration — more prominent in the overall portfolios of investors, however, most respondents said they either need more standardised and accurate data from external providers, or simply a better defined ESG investment policy internally.
According to Ye, the growing number of market standards poses a challenge in the ESG investment space. “Investors need to take a deep dive into ESG measures to marry them with their own ESG policies.”
Although the general desire among investors to enhance sustainability within all aspects of the investment process might have become overshadowed by immediate market challenges, the survey highlighted the ongoing ESG journey of the majority of respondents.
Around a third of them are developing an ESG investment policy at the moment, with some having created their own ESG scoring system and others outsourcing to third-party ESG ratings providers to inform their strategy.
Further, based on respondents, 15% of asset owners in Asia-Pacific do not have a clearly stated ESG strategy.
To make the role of ESG — and its integration — more prominent in the overall portfolios of investors, however, most respondents said they either need more standardised and accurate data from external providers, or simply a better defined ESG investment policy internally.
According to Ye, the growing number of market standards poses a challenge in the ESG investment space. “Investors need to take a deep dive into ESG measures to marry them with their own ESG policies.”
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