It’s been a bumpy ride in markets over the past few years, and uncertainty looks set to continue as we head into 2025.
Different asset classes perform better under different conditions – so what lies ahead as a multi-asset investor?
Bonds: A safe haven in volatile times?
We have been adding to bonds across portfolios on the belief they provide diversification. At the beginning of 2024, we felt a lot of interest-rate cuts were being priced into the market, so we reduced bond allocation.
During the growth scares of August, when equity markets sold off, we saw good returns from bonds, giving confidence they are once again delivering the diversification benefits investors look for, after their lack of diversification in 2022.
The market is pricing in inflationary concerns arising from both government fiscal spending and some potential policies of Donald Trump
In terms of market observations, since the US presidential election, yields on the 10-year US treasury and 10-year gilt have been moving towards 5%. This shows the market pricing in inflationary concerns arising from both government fiscal spending and some potential policies of US president-elect Donald Trump.
More recently, we have been adding back into bonds at the longer end, where we were getting yields of up to 5%, particularly in the UK gilt market. We think 5% sounds reasonable, given where inflation is.
If the central banks are successful at keeping inflation at target, that could lead to a circa 3% real return, which we believe is attractive.
Equities: Navigating high valuations
Equity-market valuations seem elevated. Valuations are in similar territory to early 2022, driven by growth stocks, particularly the Magnificent Seven. We reduced our equity exposure going into 2022 and increased it going into 2023.
More recently, however, we have been conscious of valuations. So, while equity weightings have not changed dramatically, we have made reductions within technology, given how strong this sector has been.
The boom in AI and related increase in data centres and areas like cloud computing are likely to create significant demand for electricity
Increased concentration within indices and equity portfolios is something we are concerned about, but earnings numbers are starting to grow across the broader market. One area of opportunity is stemming from the manufacturing renaissance, particularly in the US.
The boom in artificial intelligence and the related increase in data centres and areas like cloud computing are likely to create significant demand for electricity.
Alternatives: A renewed interest
Alternatives have shown weakness, but there are reasons for multi-asset investors to be attracted to the likes of renewables once more.
The weakness can partly be explained because higher interest rates resulted in greater demand for bonds, so competition for investors’ capital has been fierce. Other contributors included the debate around cost disclosure for investment trusts, as well as pension funds selling liquid assets to raise collateral and to derisk their portfolios to better match their liabilities.
One reason for our optimism is the reform of financial services retail disclosure requirements
With rising bond yields, this helped to move many pensions from a deficit position to a surplus.
With portions of their assets being in illiquid assets, this exacerbated their dependence on the liquid assets, such as the listed alternatives markets, which they had invested in to match their inflation-linked liabilities.
Certainly, one reason for our optimism is the reform of financial services retail disclosure requirements. This could entice multi-asset investors back into the investment trust area. Another reason is the inflation-linked nature of some renewables.
With concern around inflation remaining higher, the inflation-linked cash flows characteristic of the renewables space could be positive for investors, providing portfolio diversification against bonds and equities.
Paul Flood is head of mixed assets at Newton Investment Management
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