And it is at times like this that history tells us it is wise not to try to be too clever, but rather to stick to the tried and tested investment approaches to balancing risk with return at uncertain times.
But first, let’s just take stock of where we are against a background of volatile markets delivering widely differing returns, significant geo-political risks, rampant inflation and the expectation of a swift slowdown in global economic activity. Central banks are far from unanimous in their approach to tackling the problem of a rapidly rising cost of living. On the other side of the Atlantic, the Fed is adopting a hawkish stance, while our own Bank of England is looking more dovish, presumably as a consequence of the greater threat to economic growth that we face.
One effect of this has been to see the pound drift steadily downward, which will not be helping the inflation picture. While this may be attributed in part to the demand the US dollar is seeing as a perceived safe haven currency, sterling has also lost ground to the euro, which arguably faces its own set of challenges. With no end in sight for the Ukrainian conflict, the upward pressure on the price of agricultural products could be with us for some time.
Even the seemingly greater security of bonds has been called into question. Rising interest rates encourage higher bond yields, which results in falling capital values. And, anyway, where is the attraction of investing in an asset where the interest return is so significantly less than the rate of inflation – as is the case both here and in America. Cash is in much the same boat, with a declining value in real terms guaranteed. It all creates something of a conundrum for asset allocators who may be forced to choose between classes that all have unattractive elements.
So is diversification the answer? While in essence this seems the prudent solution, spreading your investments between a variety of asset classes can take great care and brings with it a set of risks that may not be immediately apparent. Foremost amongst these is the opportunity cost that investing in wide range of differing options inevitably brings. That said, it is a brave investor who is prepared to back a single horse when so much uncertainty surrounds future outcomes.
Not that diversification is always a guaranteed panacea. At the end of the last millennium a major hedge fund collapsed despite hedging its investment bets between what it thought were asset positions that were unlikely to be affected in a similar way at the same time. True, Long Term Capital Management was highly leveraged, but its track record before had been exemplary and its demise was seen as sufficiently serious to demand action from the Federal Reserve Bank which organised a bail-out to protect the integrity of the financial system.
Today diversification opportunities are very wide indeed. When I started out in this business nearly 60 years ago, cash, British Government bonds and domestic equities were really the only asset classes on offer to greater majority of investors. The presence of the investment dollar premium made investing abroad difficult and expensive. Today, as well as geographic diversification being readily available, an investor can choose between investment styles – in bonds as well as equities – as well as industrial segmentation and such esoteric options as hedge funds, absolute return, private equity and infrastructure. Even property is more accessible than half a century ago.
Quite where to start in these difficult times is more difficult. Bonds have been shedding value this year and have become more volatile. Funds that invest in a combination of bonds and equities to iron out fluctuations have not delivered as hoped. Infrastructure has been much vaunted as a suitable alternative, but the nature of these funds varies greatly, so careful research is needed. Even equities, which arguably are the best positioned to withstand, or even in some cases benefit from, inflation are likely to suffer in the current climate.
Personally, I am still inclined to back equities, but with as wide a spread as possible. US shares have had a tough time of late – particularly technology stocks. This probably has more to do with profit taking than a change in the outlook for these giants of the new economy, but it underscores the likely continued volatility as current problems persist. Back in the 1970s, when inflation was again rampant and peace shattering conflicts were also a feature, shares had a torrid time, but subsequently recovered strongly. Let’s hope it happens again.
Brian Tora is a consultant to wealth managers JM Finn.
See also: Can you forecast the economy?