Why policy divergence signals the next step in the evolution of multi-asset funds

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Five years into an equity bull market and 30 years into a bond bull market, many investors are now chasing yield and return — at the expense of risk. Risk assets can continue to do well from here, but at these valuations — and in this macroeconomic backdrop — investors could be playing with fire. Now is the time for a closer look at how multi-asset income funds can help mitigate this volatility, while generating the reliable income that cash and government bonds are now struggling to deliver, says Talib Sheikh, Fund Manager of the JPM Multi-Asset Income Fund, at JP Morgan Asset Management.

From benign investment environment to dramatically diverging world

After the financial crisis, virtually all risk assets rallied — for two main reasons. First, risk premiums were high and valuations were low. That premium has now all but disappeared across many asset classes, and we’ve seen all-time highs on indices in the US and, more recently, in Europe and Japan. Meanwhile, it’s very hard to argue that much value remains in bonds.
Second, global markets have been overwhelmingly driven by an abundant wave of liquidity provided by central bankers. The whole point of the QE programmes undertaken by many of the world’s central banks was to inflate the price of risk assets and make cash more expensive to hold. QE has unquestionably provided significant support for the markets, creating the benign investing environment of the past few years.

But this is all changing with the emergence of dramatic policy divergence between the US and Europe, and with it the varied market consequences, such as major currency shifts. As normalisation draws nearer in the US (our prediction is for a September rate hike from the US Federal Reserve), Europe’s 18-month stimulus programme is already having a significant impact on both equities and bonds. This divergence will have profound implications for asset classes themselves, and for the correlations between them.

Multi-asset income funds are moving into the mainstream

In this diverging world, it’s more important than ever to correctly interpret asset allocation opportunities — and multi-asset income strategies are increasingly giving investors the tools to do just that. What’s more, these funds have turned what was once a binary decision made by a fund manager between stocks and bonds into a multi-dimensional process spanning a more complex universe of potential opportunities, requiring a combination of macroeconomic analysis, top-down asset allocation insights and tactical investment expertise.

Multi-asset income approaches are rapidly evolving and moving into the mainstream to become a first-choice foundation for investors’ portfolios. That’s because they focus on delivering risk-adjusted returns by diversifying across asset classes to generate income and provide total return. For investors, this helps create a smoother ride for the end investor by seeking out the most attractive income-generating assets, and avoiding the most challenging.

Traditional fixed income no longer lives up to its name

And there’s another reason why central bank policies are increasingly making multi-asset income funds resonate with investors: the growing realisation that the low-risk, income-generating part of their portfolio has to be replaced. In Europe, rock-bottom or negative government bond yields mean that traditional fixed income no longer provides any actual 'income', so an allocation to a traditional bond today is nearly unfeasible. QE has left higher-risk assets as the only game in town, posing a fundamental challenge to investors that need stable returns, but can’t afford to take on reckless market risks. Multi-asset income funds can help mitigate the volatility of higher-risk exposures, while generating the reliable income stream that cash and government bonds are now struggling to deliver.

Maximising return potential in a low-yield market

In Europe, a wave of optimism about the recovery has bolstered stocks and European Central Bank QE has sent bond valuations soaring. German 10-year government bonds are now flirting with the zero, providing no income and little prospect of capital preservation when rates rise. For multi-asset income investors, this represents a valuable opportunity to capture an average dividend yield of around 4.5 per cent on European shares — ample compensation for taking on the risk of overweighting equities.