Optimizing strategic asset allocation. What you need to know
The right asset allocation is fundamental for a successful investment portfolio. Rising interest rates and ongoing volatility create risks, but also new opportunities, such as higher bond yields and investing in alternative investments. Sectors and strategies toward which investors should ideally align their portfolio.
Higher interest rates are driving rising bond yields
In the past two-and-a-half years, extreme shocks have hit the financial markets, such as the COVID-19 pandemic and this year’s energy crisis. Inflation globally spiked, due to demand from reopening economies after the pandemic, coupled with supply chain issues, caused by production halt in China. This spike in inflation triggered sharp monetary tightening by central banks.
Interest rate hikes have driven up bond yields across the entire maturity spectrum. We expect that these increases in yields herald a lasting regime change away from the low interest rate environment. Due to these changing market conditions, now seems to be the right time for many investors to review their strategic asset allocation.
Your fixed income weighting is too low? What you can do.
Investors will have great opportunities in the new year, particularly in the case of fixed-income investments. As bonds benefit from lower volatility compared with equities and exhibit a materially improved risk-reward profile, the attractiveness of fixed income markets has risen relative to other asset classes. It is therefore advisable to strengthen the core fixed-income allocation:
- Corporate credit from investment-grade quality issuers will likely become attractive when central banks signal a slowing of the tightening cycle.
- Emerging market hard currency bonds already offer an attractive return outlook as yields have reached levels that are rare in a historical context and compensate handsomely for the investment risk.
- US Treasuries: The return outlook for global treasury indices is expected to be positive in 2023. Given the current rate differentials and the different outlook in terms of further rate hikes, we see greater return potential in US Treasuries than in euro zone government bonds.
- Convertible bonds have attractive pricing in view of the correction on the equity markets.
A reduced weighting of equities in the asset allocation is advisable
The equity markets will continue to face challenges in 2023. The impact on corporate profits from a weak economy and margin pressure continues to create volatility. Investors should therefore consider gradually reducing their systematic risk. For example, by reducing the proportion of dedicated growth stocks in favor of more defensive stocks and strategies.
- Thanks to its defensive characteristics, the Swiss market usually performs above average in the event of a growth slowdown. The low unemployment rate and low inflation support Swiss equities, as well as the fact that consumers are still in a spending mood.
- Healthcare offers appealing valuations compared to other defensive sectors and earnings in line with the equity benchmark (MSCI World) for 2023. We also like healthcare for its long-term growth drivers like better healthcare access in emerging markets, an aging population, and developments of new technologies (e.g. mRNA vaccines).
- Defensive strategies such as dividend and minimum volatility fared better in a relative sense, alongside value, and were supported by higher benchmark yields.
- Defensive Supertrends: Multi-year societal trends such as our Supertrends, are not only aiming to outperform global equities in the long run, but also help to balance the risk-return profile due to their lowering correlation effect. We favor themes with less volatility, such as infrastructure and climate change.
Hedge funds, private debt and private equity as an attractive opportunity
Hedge funds should deliver above-average returns. In an environment of still elevated inflation, higher interest rates, slowing economic growth, and elevated volatility, we expect higher returns for hedge funds relative to traditional equities and bonds. However, large differences between the best and worst performers underscore the importance of selection and due diligence.
As market conditions remain challenging, we favor Global Macro strategies, which usually generate their most interesting returns when volatility rises and dispersion increases. Relative value and market neutral strategies are likely to provide an asymmetric return profile, with greater upside potential and limited downside in fundamentally stronger companies.
Private equity is not immune to slowing economic growth and rising interest rates. However, private markets should see more moderate declines than public markets. For example, in selected private market assets, the transition to a decarbonized world presents a multi-trillion-dollar market opportunity. A broadly diversified allocation to mission-driven seed, early-, and later stage venture funds should offer a predictable investment return.
Private debt is also preferred in 2023, as rising benchmark rates and risk premiums improve its future return potential, particularly given its floating rate nature. However, higher returns are somewhat offset by higher default rates in a weak macro environment. We thus highlight direct lending – a more resilient component – due to its seniority in terms of the capital structure.
Better performance with long-term investment strategies
Lump-sum investments or staggered investments – which approach works better? Credit Suisse portfolio management addressed this question. The result obtained by our experts was unambiguous: Those who invest a lump sum gain the most in the long run, closely followed by the staggered investors, with the cash seeker bringing up the rear. This means that in the long run the influence of “the first day” disappears very quickly. And the combination of “time in the market” and a “strategic asset allocation” has been shown to yield optimal results.