Article

The Big Picture – Global Asset Allocation Q3 2022

3 July 2022
Paul Jackson
Paul Jackson
Global Head of Asset Allocation Research
The Big Picture – Global Asset Allocation
Key takeaways
1
Markets are picking up pace and projected returns suggest more risk is unlikely to result in more reward over the next 12 months.
2
Central banks have adopted aggressive policies to combat higher than expected inflation. The resulting economic slowdown could risk recession.
3
Meanwhile, government bond yields are the highest in more than a decade and we find ourselves attracted to this previously shunned asset class.

Markets are moving quickly and surprisingly, we now find ourselves attracted to government bonds, an asset class we’ve shunned for some time.

The backdrop to this publication is that inflation is peaking higher and later than expected. The Federal Reserve (Fed) and some other central banks are tightening aggressively1. Government bond yields have risen to levels not seen in more than a decade (in the US) and the global economic cycle feels more fragile by the day. Central bank aggression risks turning economic slowdown into recession.

Following the results of our optimisation process, we’re increasing government bonds to Overweight (for the first time since 2016) and reducing equities to Underweight within our Model Asset Allocation*. But we don't go as far as suggested by the optimiser, as we’re wary of having too few equities after the recent sell-off. We fear that bond yields, though more generous than for some time, can still go higher. Adding to the de-risking, we also eliminate the exposure to high yield credit.

To some extent, that dampening of portfolio risk is offset by an increase in the allocation to real estate (to Overweight) and reductions in the allocations to investment grade credit and cash. Both of these remain Overweight and we remain zero allocated to commodities, including gold.

From a regional perspective, we favour UK and emerging assets (EM). Indeed, our best-in-class selection of assets (based upon 12-month projected returns) is: UK government bonds, EM real estate, Chinese equities and USD cash.

Figure 1. Projected 1-year returns for global assets and neutral portfolio

Based on annualised local currency returns. Returns are projected but standard deviation of returns is based on 5-year historical data. Size of bubbles is in proportion to average pairwise correlation with other assets. Cash is an equally weighted mix of USD, EUR, GBP and JPY. Neutral portfolio weights show in Figure 3. As of 13 June 2022. There is no guarantee that these views will come to pass. See appendices for definitions, methodology and disclaimers. Source: BAML, MSCI, GSCI, FTSE, Refinitiv, Datastream and Invesco. 

*This is a theoretical portfolio and is for illustrative purposes only. It represents the views of the authors and does not represent an actual portfolio. Nor is it a recommendation of any investment or trading strategy.

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