The prevailing market conditions and predicted uncertainty into 2024 has advisers and their clients checking their strategic asset allocations to make sure they are positioned as best they can be for what is coming, even without knowing what that is.
While uncertainty is not comfortable at any time, it is particularly hard to deal with when house prices aren’t growing, the cost of living is spiraling, and clients are already feeling financially under the pump coping with inflated interest rate payments on their mortgages.
But turning uncertainty on its head and recognising that it can present unique opportunities is a way of managing investments in challenging market conditions and beyond.
Embracing uncertainty with risk targeted investing
There is a simple explanation why uncertainty creates opportunities. It is because when market participants are unsure and uncertainty prevails, volatility tends to increase leading to a greater dispersion of assets as investors seek out value in different areas.
It is this dispersion of assets which unlocks opportunities, and investment managers such as Atrium who invest globally across a broad range of investments and have additional flexibility inbuilt to manage their portfolios, can avoid risks and take advantage of opportunities that many can’t.
This is how risk targeted investing responded to the COVID-19 environment. As volatility increased and equities markets plummeted, the strategy meant managers using this approach could proactively position investments to mitigate the impact of these market downturns on investor returns.
By embracing uncertainty and leveraging the potential presented by volatile markets, risk-targeted investing is positioned to thrive, as it can capture the benefits that arise from the dispersion of assets and the formation of trends. This approach allows managers to navigate uncertainty skilfully and seize the opportunities that it brings, ultimately, we believe that this will benefit our investors and enhance their investment outcomes.
‘Risk and Return’ is the name of the game
Risk is at the forefront of every investment decision for a risk targeted investment manager. While there is the dual goal of maximising returns while carefully managing risk, the starting point on the latter sets the investment strategy on a different path right from the beginning.
The importance of the inclusion of the risk objective, is that it ensures investors are not taking more risk at exactly the wrong time. That is, when valuations appear high, risk is elevated and the subsequent returns across markets are likely to be low. As we have seen historically; this can occur when risk is not appropriately priced and performance is the sole objective.
By having a focused approach around a defined objective such as achieving the required return above the cash rate while not exceeding a predetermined level of risk, an investor’s journey can be aligned to their expectations and uncertainty is reduced.
So although uncertainty arguably helps risk targeted investment strategies shine, by prioritising risk and agreeing to a level of risk, it is in fact reduced.
It’s all in the design
The design of risk targeted investing includes a targeted allocation to assets with a defined role, with a significant portion dedicated to diversifying assets such as liquid alternatives and private markets.
These diversifying assets prove particularly valuable in volatile environments as investment managers can act on the trends that are emerging, providing them with considerable flexibility and scope.
By embracing uncertainty and leveraging the potential presented by volatile investments, risk targeted investing is positioned to thrive, as it can capture the benefits that arise from the forementioned dispersion of assets and the formation of trends.
This approach means risk targeted managers can navigate uncertainty skillfully and seize the opportunities that it brings, which can ultimately benefit investors and enhance investment outcomes.
An all-weather investment approach
Risk targeted investing does not take a one size fits all approach to market events, instead acknowledging that every market situation is distinct. However, the fundamental approach underpinning risk targeted investing means it can fulfil a more defensive role and limit drawdowns during periods of heightened volatility.
This was the case during the bond sell off in 2022 where our portfolios were positioned away from traditional government bonds, allowing them to avoid the significant losses experienced in global bond markets. On the other hand, some of our strategies benefited at this time, smoothing the investment experience.
While it does not aim to guarantee zero negative returns for investors, its design allows it to navigate various market environments effectively.
Changing gears when investment conditions move
Inflation will be a key player in shaping investment markets over the next 12 months and beyond. Central banks have certainly been working hard to curb core inflation through the rapid increase in interest rates.
After 11 interest rates hikes, we are starting to see they are having the desired effect and reducing demand in the economy. This is not just happening in Australia but all around the world as the global economy recovers and transitions post COVID-19.
This slowdown will impact GDP which we believe is likely to trigger a recession in the US and Europe. While equity markets have been volatile, we expect this to increase as they continue to adjust to the new operating environment.
In response to changing conditions, the risk targeted investing approach is designed to adapt its asset allocation and underlying investments ahead of market movements. By actively increasing allocations to cash and diversifying investments, our portfolios position to align with the ongoing challenges faced by central banks. When the opportune moment rises, as a risk targeted investment manager, we will have the means to significantly alter our asset allocation into high-quality investments at more favourable prices.
By anticipating market shifts and proactively adjusting our strategies, risk targeted investment managers such as Atrium can position themselves to seize opportunities as they rise. Although the prevailing investment uncertainty and market volatility may persist for some time, our commitment to navigate these conditions with agility should ensure that our clients’ outcomes are optimised.
Tony Edwards is chief investment officer and executive director at Atrium Investment Management.
