What struck me most was the question around inflation. The markets are strongly focused on the impact of disinflationary pressures, such as falling food and manufacturing input prices and an easing of wage growth.

Yet on the other hand, many market participants believe we will see structurally higher inflation over the long term. This tension between the near-term and long-term outlook for inflation presents significant challenges for asset allocators in 2024.

This is particularly relevant as investors undertake their ritual start-of-year reassessment of the asset allocation mix. The debate around inflation continues to influence their stance around fixed income allocations.

At face value, the case for fixed income is compelling. Growth is weakening, albeit with significant regional dispersion. Developed market inflation continues to fall markedly. In the UK, headline inflation has fallen from a peak of 11% in October 2022 to 4% in December. From a valuation perspective, starting yields across the risk spectrum are attractive and while credit spreads remain tight, all-in yields should offer a significant cushion against spread widening from here.

But despite the constructive set-up, investors largely remain unconvinced. Why?

We think there are three key factors at play:

• The damage that high inflation caused to multi-asset investors in 2022 will remain front of mind. I expect a high sensitivity — whether warranted or not — to inflation will remain for the coming years. Investors are often sensitive to recent events, as we witnessed in the post-GFC era, where investors remained highly wary of the risk of another credit crisis.
• In the near term, the path back to central bank inflation targets is unlikely to be smooth. This may prompt many investors to hold back on duration overweights on the expectation of better entry levels.
• The secular view around inflation remains uncertain. Many argue that the forces that kept inflation at bay in recent decades have been replaced with a new set of secular forces that will keep inflation higher and more volatile over the coming years.

Is inflation gone or will it stay higher for longer?

The “higher-for-longer” view may be hard to square with the fact that inflation has already fallen much quicker than most expected, driven largely by falling goods and energy prices. We expect this disinflation trend to continue over the coming quarters as central bank policy remains tight, growth slows and labour markets soften.

While services inflation remains sticky, wage growth is slowing and housing inputs in the US, mainly via rents, are showing signs of moderating. However, there are convincing reasons why inflation should be higher and more volatile going forward. Given secular geopolitical trends, we expect a move away from globalisation towards regionalisation, which is likely to reduce efficiency within supply chains and push up costs.

The energy transition has already shown its impact on supply and demand dynamics in commodity markets and while the pace of decarbonisation and the mitigating impact of technology remains uncertain, at the very least the path for commodity prices should be more volatile going forward.

What complicates the implications for asset allocation is that without a clear near-term catalyst or an ability to quantify these secular risks, it is challenging to incorporate a secularly higher view of inflation into near-term asset allocation preferences in the face of significant cyclical disinflationary pressures.

Over the coming quarters, disinflationary forces look set to remain strong and, short of some kind of unforeseen geopolitical event or a reacceleration in underlying inflationary pressures, the direction of travel for developed market inflation into the end of the year should be lower, even if core inflation remains above central bank targets for some time.

To my mind, anything sustainably below 3% core CPI would be enough to remove some of the uncertainty and volatility in risk-free rates that has plagued asset allocators over the last two years. This is a world in which a more normal correlation relationship between equities and bonds can reassert itself, but that relationship is likely to be weaker than in the previous cycle owing to heightened inflation risk.

What are the implications for asset allocation?

Cash had an effective but short-lived reign as king of the asset classes. Given the generational reset for multi asset investors in 2022, and a likely fall in short-term interest rates over the coming year (barring any surprises on inflation) the set-up for risk assets versus cash for long-term investors is constructive.

An active asset allocation approach can help investors smooth the path of returns. The amount of risk investors should take in asset allocation timing depends on their time horizon and risk tolerance but deploying cash allocations gradually into traditional asset classes such as fixed income and equities through periods of market volatility can help investors manage risk while deploying cash. Higher starting yields mean that investors don’t need to get too creative about seeking returns from the defensive bucket within portfolios, and for the growth bucket, while spots of the market appear fully valued, global equity valuations are not wildly expensive.

This is not to say that investors should ignore potentially disruptive structural forces. Inflation may well raise its head again over the coming years but without defined catalysts and timelines, I think investors should approach these risks with moderately sized strategic allocations to areas such as real assets and inflation-sensitive parts of the equity market, which can help ride out inflation-induced volatility.

Facing the inflation dilemma head on

Time in the market beats timing the market for most investor types. Those waiting for the all-clear on inflation might be waiting a long time or miss the proverbial boat as markets adjust quickly. By firmly embedding diversification into their strategic asset allocation, investors can face the inflation dilemma head on with a well-diversified portfolio, rather than waiting for the perfect entry point that may never come.

In the portfolio’s simplest form, the gains – and therefore the risks – come from equities, while the containment – the main source of income – is provided by bonds. The proportions are dependant on the taste of the investor and whether they have an appetite for return or security.

But the inventor of the MPT himself, Nobel-prize-winning economist Harry Markowitz,  acknowledged that this was never intended for running an individual’s portfolio, but to be applied to open-ended, undated, mutual funds with daily cashflows seeking to grow in value.

He said: “The investing institution I had most in mind when developing portfolio theory for my dissertation was the open-end investment company or mutual fund.”

If the inventor himself ignored MPT for his own pension, advisers and income seekers would be wise not to ignore him.

In spite of this, virtually all investment theory directed at the UK retail market continues to be some restatement or rehash of MPT based on analysis commissioned by institutional investors for funds, not people. This is frequently then re-badged by the marketing departments of fund management firms to suit their own ends when soliciting new money.

We argue that MPT has become a less appropriate strategy in recent years, but nowhere is this more apparent than when seeking to generate long-term income. The primary objective here is certainty of income, not capital growth. This need is invariably for income that arrives in investors’ bank accounts with the same regularity as their monthly bills. Most income investors are retirees who need to replace a monthly pay cheque.

However, fund managers usually have different objectives. They may have a remit to provide an income – which allows their fund to be marketed to income seekers – but they have less explicit goals that might not benefit the end investor.

The reality is that competition for assets often makes maintaining and growing capital an equally important objective because it improves a manager’s position in fund league tables. And of course, more assets and higher values mean increased ad valorem fees for managers.

There is clearly some dissonance between what income-seekers need and how the industry goes about meeting that need. The main risk to a fund manager is that their returns fall below the benchmark and peer group – the risk to a retiree is that the expected income is not delivered.

Essentially, MPT reduces volatility by combining assets whose values move differently to each other. This approach can work with a long-term, open-ended pension fund or scheme with continuously variable cashflows, but not for an income investor who’s timescale is finite and expenses have a fixed baseline.

The biggest difference between a pension scheme and a typical income investor is that the former has monthly cashflows coming in from both investors and employers. For the income seeker, every penny of income being paid out has to be generated by their pension or income pot, which is often their sole source of investment income.

An investment consultant can afford to get it wrong when advising a DB scheme because there is no harm done to the scheme retirees when the employer is legally obliged to sign blank cheques to meet any shortfall.

This is not so with individual income investors. Not only do they have their regular monthly income switched off, but they must also be cashflow income investors as well – a task hard enough for most advisers, never mind their end clients.

Doug Brodie is CEO of Chancery Lane

This article was written for our sister title Portfolio Adviser

Overall, 84% of investors surveyed plan to up their risk over the next 12 months, with one in 10 planning to make “dramatic increases”.

Meanwhile, 15% will keep risk levels the same while 1% will make dramatic decreases.

The study surveyed pension funds, insurance asset managers, family offices and wealth managers who collectively manage around $544bn (£430.8bn).

Looking further ahead, investors plan to further up their risk levels. Over a third (38%) of survey respondents said they will make dramatic increases and 44% will make slight increases over the next three years. An additional 17% said they expect to maintain current risk levels and 1% said they will decrease them dramatically.

See also: Sector in review: IA £ Strategic Bond

Over the next three years, 88% of respondents also revealed they plan to have a more global fixed income allocation, with 35% intending to make dramatic increases.

Khalid Khan, Aeon Investments head of portfolio management, said: “Increasing global fixed income allocations maximises diversification across all markets and issuers, and can have a positive influence on the portfolio’s risk return profile. The same is true of incorporating a broad range of asset classes and sectors.”

He added: “Investors should seek a manager that offers experience and demonstrable track record across the fixed income spectrum.”

This article was written for our sister title Portfolio Adviser 

The UK, like many other global economies, is currently experiencing a period of unusually high interest rates. This situation presents both challenges and opportunities for savers and investors.

In this article, Andrew Waring director of intermediary at Stubben Edge Group & Akoni, explores the current state of high interest rates in the UK, predictions for future rate changes, and the strategic benefits of locking into higher rates now through fixed-rate financial products.

The current state of high interest rates

The recent hike in interest rates in the UK has been influenced by a combination of factors, including economic recovery post-pandemic, inflationary pressures, and political tension. As a result, The Bank of England has been adjusting its base rate as a tool to control inflation and stabilise the economy. The base rate currently stands at 5.25% (Bank of England, November 2023.)

However, this increase in the base rate has had a ripple effect across SWAP rates as well as various financial products, including savings accounts, mortgages and loans.

For savers, this environment presents an opportunity to earn higher returns on deposits, as banks and financial institutions are offering better interest rates on savings accounts and fixed-term deposits than have been seen in recent years.

This extends particularly to fixed-rate accounts. Interest rates are predicted to start decreasing in 2024, so by bagging a fixed rate now, your clients could reap the rewards of these high rates long after they stabilise.

Predictions for interest rate changes

Looking ahead, the trajectory of interest rates is subject to numerous influences, including economic growth, employment rates, and global economic conditions. Most financial analysts predict that the Bank of England will continue to increase rates in the short term to combat inflationary pressures. However, these rates are not expected to rise indefinitely.

There is a general consensus that once inflation is brought under control and economic growth stabilises, interest rates will plateau and eventually decrease. The timeline for these changes, however, remains uncertain but current predictions expect the decline will begin in mid-2024.

The impact of unstable SWAP rates

In recent times, the instability of SWAP rates has caused mortgage interest rates to increase considerably, meaning fixed-term mortgages haven’t been so appealing.

Now, SWAP rates have started to decline, meaning fixed-term mortgage rates are looking increasingly attractive to home buyers.

The case for locking into higher rates now

Given the current high-interest-rate environment and the uncertainty about future rate changes, there is a compelling argument for locking into higher rates now, especially for those looking for security and predictability in their returns.

Fixed-rate financial products, such as fixed-rate bonds or fixed-rate savings accounts, allow your clients to secure a high interest rate for a set period.

Here are some reasons why locking into a fixed rate account now could benefit your clients long term:

• Security and predictability: Fixed-rate products offer security against future interest rate drops. By locking in a rate now, your clients are guaranteed a fixed return for the duration of the term, regardless of market fluctuations.
• Planning and budgeting: Fixed-rate returns facilitate better financial planning and budgeting. Knowing exactly how much interest your clients will earn over a set period makes it easier to plan for future expenses and investments.
• Higher interest earnings: With current rates being comparatively high, locking into a fixed rate now could mean securing a higher return than what might be available in the near future, as rates stabilise or decrease.
• Diversification: For those with a diversified investment portfolio, fixed-rate products can add a stable, low-risk component, balancing out higher-risk investments.

Choosing the right fixed-rate product

If you’re working with a client who’s considering a fixed-rate product, it’s important to ensure the one chosen aligns with their financial goals and circumstances, as not all products are the same.

You might want to consider the following:

• Term length: Fixed-rate products typically range from one to five years. Longer terms often offer higher rates but require your clients to lock away their money for a longer period.
• Interest payments: Some products offer monthly interest payments, which can be beneficial if your clients rely on their savings for income. Others compound interest annually or at the end of the term, which can be more suitable for long-term savings goals.
• Minimum investment: Be aware of the minimum deposit requirements, which can vary significantly between products and institutions.
• Access to funds: Most fixed-rate products do not allow access to funds during the term without incurring a penalty. Ensure that your client can commit the funds for the entire term.
• FSCS protection: Ensure that your client’s savings are protected under the Financial Services Compensation Scheme (FSCS), which protects deposits up to £85,000 per financial institution.

The bottom line

The current high-interest-rate environment in the UK offers a unique opportunity for savers and investors. Locking into higher rates now through fixed-rate products can provide financial security, predictability and potentially higher returns.

However, it’s crucial to carefully consider your client’s personal financial situation and objectives when choosing the right product. As with any financial decision, staying informed and consulting with financial advisors can help you make the most of these high-interest-rate opportunities for your clients.

This article was written for International Adviser by Andrew Waring director of intermediary at Stubben Edge Group and Akonia.

At a time when markets have been buffeting due to inflation, triggering rising bond yields and an uptick in the risk-free rate, some investors have been turning to alternative asset classes including hedge funds, commercial property and infrastructure to provide them to smooth returns and reduce market sensitivity.

Some investors warn against alternative assets accounting for a majority of a portfolio, given their complexity and – often – higher costs. But should investors who have traditionally stuck with the 60/40 split embrace the diversification that alternatives can bring?

Andrew Hardy, head of investment management at Momentum Global Investment Management (MGIM), points out that if done correctly, portfolio diversification can give investors with the ‘free lunch’ of steady and competitive returns, with a lower risk profile than the broader market.

“It rarely pays over the very long term to put all your eggs in one basket when investing,” he tells International Adviser. “That is truer than ever today, particularly after parts of the equity market have really dominated. The US market and the global equity indices are very concentrated and a handful of stocks represent the past winners, when actually the best returns might come from elsewhere.”

When discussing the traditional 60/40 portfolio, Hardy highlights two key problems – the first being a lack of diversification.

He says: “Our strategic asset allocation in portfolios would include credit, inflation-linked bonds, alternatives, precious metals, and most significantly, real assets as well.

“Property and infrastructure in particular have been very valuable over the course of the last couple of years during a period of higher inflation because they have better pricing power, and they can provide better protection in a higher inflation environment.”

The second problem with the 60/40 portfolio, according to Hardy, it their “static nature”, suggesting that even if investors only wanted equities and bonds in their portfolios, there will be times when they want more or less of one or the other.

“This is a period where if we [Momentum] had an equity/bond portfolio we would have been very underweight fixed income for a long time but now we’re moving much more towards neutral to slightly overweight overall.”

Hardy points outs that, although multi-asset portfolios have disappointed over the last couple of years as equities and bonds have lost money, that doesn’t necessarily mean that the idea of combining asset classes should be thrown out with the bath water following a difficult few years. In fact, he says that the argument for having a multi-asset diversified portfolio is stronger than ever in today’s environment.

“We are now in this more ‘normal’ environment and we are in a later cycle environment, where the risks of recession are quite elevated. You are being very well paid within fixed income to take on a bit of diversification and protection within that.”

Choosing alternatives

Alternatives tend to be less correlated with other asset classes, says Hardy, with the least correlated investments across Momentum’s portfolios including hedge funds and market neutral-type strategies.

He says: “The strategy we [Momentum] allocate to there did really well last year, that was up 8% when pretty much everything had fallen significantly. This highlights the benefits that come from that area.”

While real assets do tend to be more sensitive to market sentiment, the likes of infrastructure are often monopolistic and boast superior pricing power, meaning they can better protect against inflation.

Another key area for earning potential that investors can tap into, Hardy suggests, is private assets.

“Over the last 15 years or so more and more companies have chosen to stay private and deferred listing. Klarna, for example, would be one that we [Momentum] have exposure to, the so-called ‘unicorns’ that have multi-billion dollar valuations but no intention to list anytime soon,” says Hardy.

He suggests that investors who don’t have exposure to private assets are potentially missing out on growth opportunities and what he calls the ‘next wave of innovation’.

“Some of the most disruptive, highest growth businesses are staying private for longer so you need a way to access those,” adds Hardy.

Even though alternatives can contribute to the idea of diversification being a ‘free lunch’, Hardy warns they can be challenging due to their illiquid nature, and warns that investors need to be careful to avoid creating a liquidity mismatch in their portfolios.

“Our multi-asset portfolios are daily dealing so, to avoid a liquidity mismatch, we access these assets through listed vehicles, such as investment trusts – closed-ended funds that trade on the stock exchange,” explains Hardy.

UK-listed investment trusts are currently trading at significant discounts to the net asset value ,which Hardy suggests is a ‘really good opportunity’ for investors.

Looking beyond cash

Investors have increasingly been questioning why they should be investing in the likes of equities and bonds when they could be getting 5% on cash sitting in their bank. This means both asset classes have suffered net outflows.

Hardy suggests that the same applies to alternative income-producing asset classes: “In the last ten years or so a lot of money was going into investment trusts because they were able to offer high single-digit yields in many cases, whereas now suddenly there has been a lot of selling pressure in that area, leading to discounts. This has been bad for investors looking in the rearview mirror, as it can mean they haven’t really made that much money.”

Looking over the medium-to-long term, however, Hardy believes that the return potential is actually very good for those buying trusts at a discounted rate.

Stick with multi-asset

Overall, Hardy says that Momentum is telling its multi-asset clients to ‘stick with it’, despite challenging market conditions.

“Don’t be put off by performance over the last couple of years on whatever multi-asset strategy you are using, the benefits of diversification and a long-term approach are truer now than ever and the return potential from here is actually very attractive on a medium-term view from now,” he says.

Hardy adds that investors should not be put off by the risk of recession, as they can create ‘a cycle of creative destruction’ whereby the bad investments are weeded out, while the good investments become stronger.

“If you strip out the performance of the big so-called Magnificent Seven from the global equity market, performance has been very weak so a lot of risk has been priced in already. Therefore, even if you did have perfect foresight that a recession is coming, valuations might be discounting a lot of that anyway so there might not be too much downside,” Hardy points out.

He adds that he is “pretty confident” that inflation is on the cusp of falling and, historically, periods following a peak in inflation have been “incredibly lucrative” for investors.

“It stands to reason that, if inflation starts falling, interest rates can start to come down and historically this has meant very high returns – in many cases double-digit annualised returns – over five years.”