It is widely accepted that the economic landscape in the wake of the coronavirus pandemic will be markedly different. Some changes will be transient, others will be structural and long lasting.
In the short to medium-term, rising inflation, higher bond yields and possibly tighter monetary policy have the potential to disrupt asset markets. However, the environment also presents asset managers with new opportunities as the global economy undergoes what could be its most fundamental restructuring in decades.
In this blog, Matthew Bullock of Vanguard’s portfolio sub-adviser Wellington Management discusses how its multi-asset strategy will adapt to heightened market volatility, while at the same time positioning itself to exploit potentially lucrative long-term trends.
Commentary by Matthew Bullock, Investment Director, Multi Strategy Solutions & Thematics, Wellington Management Company.
The Wellington multi-asset strategy is the world’s longest established of its type, having been in existence for over 90 years. Launched in the same tumultuous year as the Wall Street Crash, it came through the Great Depression to navigate many thousands of investors successfully through multiple cycles of war and peace, boom and bust. It’s a feat that has been achieved through remarkable consistency based on the application of a rigid set of investment principles that have not wavered through good times and bad.
Bonds play the anchor role
The foundation of long-term investment success in our view is capital preservation. Only by limiting the impact of the drawdowns that inevitably occur over the course of a cycle can a stable platform for performance be built. For this reason, we employ fixed income as an anchor within the strategy, which acts as a diversifier in times of falling equity markets rather than as an explicit driver of total returns. Assets that are more correlated with equities, such as high-yield bonds, do not serve this purpose and are therefore excluded.
While this watchful philosophy also forms the cornerstone of our approach to managing equities, we do not believe that being conservative should compromise returns. When you are in for the long haul, our experience shows that emphasising undervalued, high-quality businesses with sustainable dividends enables more consistency and a better performance for a given level of risk. Our global equity strategy has adhered to this philosophy for decades and over the past 10 years delivered greater annualised returns relative to the MSCI World Index – and with less volatility1.
Resilience and innovation through Covid to be rewarded
The need for a focus on ‘quality’ is particularly relevant now that a proportion of the expected recovery is already priced into cyclical stocks. But despite the risk that this causes markets to lose traction, we remain constructive as, in the context of the coming economic cycle, investors do not appear to be fully appreciating the strong and stable earnings power of the type of resilient companies we hold in the portfolio. Indeed, those businesses that survived the Covid-19 extremes and invested in innovation look set to be rewarded, with industrials, financials and healthcare being among the most likely winners in our view.
In fixed income, despite the headwind of rising inflationary expectations we continue to hold the course. Government bonds still play an important dual role both as a backstop against a collapse in risk sentiment and a source of portfolio liquidity. For corporate bonds, fundamentals should improve with the broad economy over the course of 2021, while the technical environment is supported by strong demand for US fixed income. However, as valuations are tight, we are positioned with a neutral stance on corporate credit relative to the all-credit benchmark with a bias toward defensive sectors with lower earnings volatility.
Profiting from asset mispricing
Despite the prospect of an extended period of low returns, we are confident that our strategy will continue to meet investors’ needs. While the landscape may change, we expect to profit from the mispricing of assets – a phenomenon that will always be present in markets regardless of the stage of the cycle. Allocating capital at the right time to unloved companies that other market participants have given up on has been one of the most dependable sources of added-value for the strategy down the years. For the Vanguard Global Balanced Fund, for example, stock selection has been a valuable contributor to overall returns since the fund’s inception in 2016, particularly in cyclical areas like industrials and financials2.
The low-return world is also likely to see the best rewards earned by bottom-up investors such as ourselves. This is unlikely to remain a ‘beta play’ environment. Those managers that have the necessary scale of resource to drill down on company fundamentals on a global basis will be best positioned to outperform in what is likely to be a highly differentiated market.
Consistency remains key
Over the course of its nine decades, our multi-asset strategy has successfully brought investors perhaps the most valuable benefit of all: peace of mind. Thanks to discipline, risk-awareness and deep and long-standing experience across multiple cycles, it has anchored many thousands of investors through turbulent times. These attributes will stand it in good stead as the global economy undergoes the next phase of its evolution.
1 Source: Wellington, Bloomberg. Correct as at 31 December 2020. Comparison of Wellington Global Quality Equity Composite vs MSCI World Index: annualised gross return = 10.63 vs 10.5; standard deviation = 13.41 vs 13.96.
2 Source: Wellington, based on data from Bloomberg. Notes: attribution analysis of equity portfolio returns since 31 May 2016.