How to invest in the current environment
Stefano Torti, Group Head of Asset Management & Advisory at Banque Havilland
In investing, every new year seems somehow more difficult than the previous one. 2023 would be at first sight no different in that respect, with inflation, wars, real estate cracks, and bank failures as only some of the worries that investors have experienced so far. Nevertheless, a cold and analytical asset allocator could disagree and consider the current environment easier than the previous one. The basis for this contrarian opinion resides in one asset class that for the last 10 years has been considered more of a drag and a headache, but now it is an important tool that can be used actively to improve a portfolio’s expected return: cash. Indeed, with nominal interest rates at a multi-year high and a constant improvement of real rates, money market funds and liquidity solutions provide a pillow of performance where doubtful investors can rest when they lack conviction to invest in more risky asset classes.
However, in the current environment, it is also important not to lose sight of the strategic asset allocation and selectively start to engage again beyond short-term bonds, in order to minimize the so-called “reinvestment risk”, which is especially present at the end of a hiking cycle. Generally speaking, for fixed income, in an environment where the future path of interest rates remains uncertain, investors should continue to maintain a healthy diversification in terms of exposure to fixed and floating/variable interest rates bonds, senior loans, securitized credit, and potentially also private debt. In terms of rating and geographies, selectivity remains paramount, as a technical recession or even a hard landing is still not impossible.
When it comes to equities, in the current environment investors should pay attention to what is happening below the surface of market indices. As it has been widely reported, 2023 was a year of record concentration, especially in the US, with the so-called “magnificent 7” stocks accounting for most of the market performance. The reverse side of the coin is that there are plenty of stocks and market segments that did not have any re-rating and are still trading at reasonable or in some cases attractive valuations. One example could be small caps, which are both in the US and Europe at or close to the bottom of their relative value chart compared to large caps. The same could be said for some areas of emerging market equities. Valuations however should always be addressed in the context of where we are in the economic cycle, the market flows, and the technicals which still provide a negative picture for some of these themes. For this reason, it is wiser to engage in more time diversification and rely on several different entry points when scaling up a position.
Finally, for alternative investments and private markets, it is remarkably difficult to generalize. For example within the private equity space “secondaries” can be relatively attractive while the environment might be challenging for other specific buyouts or growth strategies. The same could be said for private debt, where some segments are likely to face less competition due to tighter liquidity while others will struggle in the face of an increase in defaults; selectivity remains once again key to keeping risk under control. A similar approach should be used for hedge funds, where investors ought to carefully look at dispersion and trends in order to allocate to the right strategies and managers.