What are the options for structuring a low risk portfolio?

Anthony Rayner

Premier Miton Macro Thematic Multi-Asset Team

This is the second in a series of three pieces that look at low risk assets. In the first, we illustrated how risks change over time, as do the risk profile of assets. As a result, we concluded that what constitutes “low risk” is a moving feast. In this piece, we set out what we believe to be the numerous “risk levers” available to global multi asset funds.

As we set out last week, US Treasuries are considered a traditional safe haven, but this has been challenged during the more recent inflationary environment. Nevertheless, bonds in general are the largest asset class in the world and, with that, comes numerous sub-asset classes.

For example, some are more cash-like, such as short-dated bonds in the developed government bond and investment grade corporate bond space, while others are more equity-like, such as high yield corporate bonds. Even within government bonds, there is quite a range, from US government debt to riskier emerging market government debt. Meanwhile, across bonds, duration varies, which reduces or increases interest rate risk.

Corporate bonds are not only driven by their degree of credit risk and interest rate risk, they also reflect some of their industry’s characteristics, which can be important. For example, the largest industry in the US high yield corporate bond universe is energy, by some margin. Meanwhile, asset-backed securities are generally floating rate, with less duration, so are less exposed to rate rises. In short, there are quite a few different risk options to access within fixed income.

Just as with bonds, not all equities are the same, with industries being key drivers of performance. For example, there are economically sensitive industries, like financials, inflation beneficiaries such as materials and more defensive industries, such as utilities and consumer staples. That said, as illustrated above, risk is not a static concept and, just as safe havens change depending on the main source of risk, so-called defensive equity sectors might prove to have a higher risk relative to other equity sectors if the main source of risk challenges that sector most.

Equity style is also an important determinant of performance and risk. The same dynamic that drove bond yields lower has also benefited growth stocks, as a lower discount rate benefits the present value of stocks that have an earnings stream more weighted towards the future. As inflation has risen, along with expectations of the discount rate, so growth stocks have suffered more than value stocks, with the latter tending to have an earnings stream more weighted towards the present.

However, there are more assets available to a mixed asset investor than just equities and bonds, for example commodities. Even here there are a range of sub-asset classes with very different characteristics, which means that one class will likely be lower risk than the others, again, depending on the main source of risk.

Take the oil price; it’s generally driven by supply rather than demand, as the latter tends to be more consistent, with supply sensitive to the often politically fragile source countries. Industrial metals, meanwhile, such as copper, are more driven by economic cycles, as the related demand tends to be more volatile than supply. Gold, on the other hand, as a precious metal, is considered more of a safe haven, with supply somewhat limited and industrial applications less than many of the other traded metals.

Meanwhile, agricultural commodities are driven by supply changes (often through volatile weather patterns), as demand is driven by a steadier increase, as populations grow. Additionally, the cost of inputs such as fertilizer are important, which in turn are materially driven by energy costs.

Property is another option for multi asset investors. As a real asset, it tends to be more inflation friendly, with some diversification to equity. Liquidity can be an issue here, due to the nature of the underlying asset, and REITs can offer a better option in this regard.

In fact, liquidity is an important consideration across assets, and one which is often underappreciated. It’s not just the volatility of an investment, and how it behaves relative to the rest of the portfolio (correlation) that drives risk. For example, an illiquid asset can appear to have a low volatility just because it doesn’t trade, though it often shows its true colours during a risk episode. So, when thinking about low risk assets, decent liquidity is an important factor too.

Finally, there are currencies, which are often not viewed as an asset class per se, but do have varying levels of risk associated with them. For example, the Japanese yen and Swiss franc are considered more of a safe haven, as ever, depending on the dominant risk source.

In short, pigeon-holing assets is at best driven by looking at shorter term histories, and at worst, driven by lazy assumptions. As night follows day, what constitutes a low risk asset will change, so we believe multi asset fund managers need to keep an open mind and a liquid portfolio.

Ultimately, it comes down to which risks we need to worry about, as different assets will provide protection against different potential outcomes. If the risk is inflation, very different assets are needed now, compared to the last thirty years.

We conclude this series on low risk assets with our final piece next week. We will look at what we believe to be some of the different options for low risk asset fund solutions, as well as taking a look at how the Macro Thematic team’s low risk fund, the Premier Miton Defensive Multi Asset fund, is currently structured.

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Risks

The value of stock market investments will fluctuate, and investors may not get back the original amount invested.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Government and corporate bonds generally offer a fixed level of interest to investors, so their value can be affected by changes in interest rates. When central bank interest rates fall, investors may be prepared to pay more for bonds and bond prices tend to rise. If interest rates rise, bonds may be less valuable to investors and their prices can fall.

Where investments in a fund are denominated in currencies other than sterling (for example, if a fund holds assets priced in euros), its value will be affected by changes in the relevant exchange rate. Certain other investments, such as the shares in companies with profits from other countries, will also be effected.

Equities (shares) can experience high levels of price fluctuation.

Commodity prices can fall and rise sharply depending on supply and demand, the economic background and financial market conditions. Exposure will never be direct to any commodity.

Property values can rise and fall sharply depending on the strength of a country’s economy.

Future forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

For your protection, calls may be monitored and recorded for training and quality assurance purposes.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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This section of the website and the content it contains is for retail clients only and by persons who are resident in the United Kingdom [who are not US persons]. Professional advisers should refer to the Professional Advisers site.

The content of the pages of this website is for your general information only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

You acknowledge that such information may contain inaccuracies or errors and we expressly exclude liability for any such inaccuracies or errors to the fullest extent permitted by law. Your use of any information or materials is entirely at your own risk, for which we shall not be liable.

The information contained on this website does not constitute an offer or solicitation to sell or purchase shares in the funds or portfolios or to provide you with other products or services. Any application or investment must only be made on the basis of the relevant documentation of the investment, such as, for example, terms and conditions. The information on this website does not constitute any investment, tax, legal or other advice. Persons who do not have professional experience in matters relating to investments should always consult with an independent financial adviser before making an investment decision. Any opinion expressed on individual funds, services or products represent the views of the individual at the time of preparation and should not be interpreted as a personal recommendation to buy or sell or otherwise trade all or any of the investments that may be referred to.

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This section of the website and the content it contains is for professional financial advisers only and should not be relied upon, or circulated to, retail clients. Retail clients should refer to the Private Investor's site.

The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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