Fixed income will offer more opportunities for active investors over the next few years as the asset class reacts to a changing economic and political environment. In doing so, bonds will provide investors with the potential for enhanced diversification and this supports our positive view of the future role of the 60/40 or balanced portfolio.
A key driver of this outlook is the fragmentation of globalisation and the move towards a more multi-polar world. In this environment, it is likely that some of the absolute efficiency that stems from globalisation will be foregone for shorter supply chains and protectionism. We believe this approach will be marginally less efficient than the supply chains we have seen criss-crossing and developing across the globe over the past few decades.
We believe this will lead to inflation being higher – although not at elevated levels - than we have become accustomed to over the last decade. This is likely to be reinforced by the policies of the second Trump presidency, including if his threatened tariffs are implemented against China and Europe. Interest rate reductions have already been slower than expected. With this backdrop, tighter monetary policy and lower liquidity could cause higher market volatility.
Another consequence is that economic cycles across the major economies are likely to be less in sync that we have come to expect. This will lead to increased diversity in actions by central banks, including interest rates no longer moving in near unison, whether up or down. This will in turn make it more beneficial to actively manage duration within the fixed income portion of portfolios going forward to take advantage of the diversification in interest rate policies.
What will this mean for the outlook for balanced portfolios in which 60% are invested in equities and 40% in fixed income? They have been effective traditionally because growth is primarily delivered through equities over the long term and the fixed income exposure helps to smooth any volatility of returns through its diversification away from equities and in its payment of income.
Historically, equities and bonds are negatively correlated. Intuitively, this makes a lot of sense . For example, what is bad for sovereign bonds – good economic data – tends to be good for equities, including through the positive impact on earnings. And bond yields tend to come down and therefore prices rise when risk aversion increases.
A notable exception to this long-term trend of negative correlation was 2022, which was only the fourth calendar year since 1928 in which US bonds and equities fell in tandem. Several factors combined to lead to this unusual positive correlation. Inflation soared following the Russian invasion of Ukraine and the steep rise in energy prices. Central banks moved to tackle the much higher rate of inflation by raising interest rates in a way we had not seen since the 1970s, which was characterised as fast and furious. This led to a general fall in equities, which was followed in turn by bonds.
The fact that sovereign yields were close to or at all-time lows (and indeed negative in many instances) meant the outsized yield adjustment required was more uncomfortable. Indeed, government bonds suffered their worst return in 2022 in 20 years (with 2021 the second worst).
But now we expect to see equities and bonds increasingly move back towards their historic levels of negative correlation. Bonds are currently providing a real return above pervading inflation rates, meaning investors in bonds are paid to wait while they receive a relatively attractive level of income. This is a traditional benefit of fixed income investing that had been forgotten since the Global Financial Crisis. We also believe that following the repricing of bonds in recent years, fixed income investing will have a greater positive benefit for portfolio construction.
All of these developments are serving to reiterate why we believe in the positive role that the 60/40 portfolio can play for investors in the future, especially when actively managed with a long-term outlook.
KEY RISKS
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.
The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
The Funds and Model Portfolios managed by the Multi-Asset Team may be exposed to the following risks: Credit Risk: There is a risk that an investment will fail to make required payments and this may reduce the income paid to the fund, or its capital value. The creditworthiness of a bond issuer may also affect that bond's value. Bonds that produce a higher level of income usually also carry greater risk as such bond issuers may have difficulty in paying their debts. The value of a bond would be significantly affected if the issuer either refused to pay or was unable to pay; Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss; Liquidity Risk: If underlying funds suspend or defer the payment of redemption proceeds, the Fund's ability to meet redemption requests may also be affected; Interest Rate Risk: Fluctuations in interest rates may affect the value of the Fund and your investment. Bonds are affected by changes in interest rates and their value and the income they generate can rise or fall as a result; Derivatives Risk: Some of the underlying funds may invest in derivatives, which can, in some circumstances, create wider fluctuations in their prices over time; Emerging Markets: The Fund may invest in less economically developed markets (emerging markets) which can involve greater risks than well developed economies; Currency Risk: The Fund invests in overseas markets and the value of the Fund may fall or rise as a result of changes in exchange rates. Index Tracking Risk: The performance of any passive funds used may not exactly track that of their Indices. Any performance shown in respect of the Model Portfolios are periodically restructured and/or rebalanced. Actual returns may vary from the model returns.
The risks detailed above are reflective of the full range of Funds managed by the Multi-Asset Team and not all of the risks listed are applicable to each individual Fund. For the risks associated with an individual Fund, please refer to its Key Investor Information Document (KIID)/PRIIP KID.
DISCLAIMER
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.
This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.
