Who needs conservative investments?
The equity markets are hurtling from record to record, bitcoin rose to USD 60,000. And yet there are still investors who opt for conservative multi-asset funds. Why is that?
In recent years, the major central banks have increasingly adopted more accommodative monetary policies and have lowered the interest rates they set to zero percent or even lower. As a result, an increasing number of banks are charging negative interest rates of up to -0.5 per cent on call and fixed-term deposit accounts, and when inflation is factored in, things look even bleaker. Conversely, this has resulted in an even stronger rise in the prices of other assets, and the universe of bonds with negative yields has grown to almost USD 17 trillion in the past year. TINA ("there is no alternative") is making the rounds, share prices are breaking record after record, real estate prices are exploding and bitcoin reached USD 60,000 at its recent peak. So why do people invest their assets in defensive multi-asset funds and thereby to a significant extent in low-yielding bonds? And this at a time when yields can only go up and therefore bond prices will fall. There seems to be no lack of attractive investment opportunities, as they could also invest all of their assets in shares or cryptocurrencies.
At this point, however, investors should sit up and take notice. Should they really put all their eggs in one basket? Is it enough to diversify into different stocks within an equity portfolio or do you need diversification across different asset classes? This is where the risk appetite of the respective investor plays an important role. Even if bonds barely offer a positive return, the short-term fluctuations in value (‘volatility’) and the maximum loss in value in times of crisis (‘maximum drawdown’) are significantly lower than with equities. A broadly diversified portfolio of corporate bonds, for example, also recorded significant losses during the crisis in March 2020, but considerably less than an equity portfolio. Sovereign bonds even made gains, and losses were also recovered much more quickly. Other factors, such as personality, age, investment horizon and return expectations, play an equally important role in choosing the right investment solution. If an investor who has already built up their wealth through investments over many years suddenly suffers losses of 20% to 30%, they quickly become nervous and may react by selling at an inopportune time. This is in contrast to young investors who have high return expectations, a modest need for hedging and who are far more likely to ride out temporary valuation losses and to have a second, stable income. They are more likely to put all their eggs in one basket and invest only in equities. However, there are also examples of how it can take a very long time for equity losses to be recovered. Despite its recent significant gains, Japan's Nikkei is still trading at more than 20% below its historic record set in 1989.
This in turn shows that timing can be an important factor in investing. In the long run, it hardly matters whether an investment in a broad index, such as the S&P 500, was made at the end of 2007 or only at the end of 2008 – that is either before or during the global financial crisis. Both investors earned at least 150% with their investment. However, for the buyer of a single stock, for example a large car manufacturer like Daimler, the situation is quite different. While the investor at the end of 2007 was happy to be back in the black thanks to the strong profits that year, the investor at the end of 2008 could sit back and relax because his investment had almost tripled. And what if global equity markets are currently where the Nikkei was in 1989? Couldn't the introduction of a global minimum tax on the profits of multinational companies, as is currently being discussed, be a watershed in the ongoing bull market? If so, it could take a long time, if not a very long time, for a current investment to break even.
With bonds, investors have more clarity. Bonds must be repaid within their duration at the interest rate agreed at the time of the investment. Interim price losses will have been made up by then at the latest. This promise does not apply to shareholders.
Afterwards, an investor can reinvest their money, hopefully at a higher interest rate: the shorter the remaining maturity, the faster it can be reinvested. In the case of 30-year bonds, this point in time is still very far away, so that interim price losses can at times be quite high. This is more likely to occur if the starting point, as is currently the case, is at a very low yield level. However, in most cases the repayment is safe.
There will always be periods that are more favourable for individual asset classes, with the result that they outperform others. However, the concern that current valuations are still very high is justified. Therefore, know-how and financial market expertise are necessary to identify attractive investment opportunities. In order to free clients from having to choose between the various investment options, there are actively managed multi-asset funds. Here, a capital market expert decides in which asset classes the clients' assets are invested. They use a wide range of investment options: equities, bonds, gold, currencies and, to hedge against high price losses, derivative products such as futures and/or options transactions. The portfolio manager actively adapts the portfolio to the market environment. Therefore, clients who want to benefit from a strategy with a manageable level of risk in order to preserve their assets and, in addition, achieve a return, cannot overlook actively managed multi-asset funds. These products are designed according to the different investor profiles, so that even investors with a low risk tolerance will find what they are looking for. As such, conservative products are particularly suitable for those investors for whom capital preservation and the avoidance of significant drawdowns are of the utmost importance.
Please contact us at any time if you have questions or suggestions.
ETHENEA Independent Investors S.A.
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