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With equities stumbling on rising core inflation in the United States, the market is left to grasp for a clear strategy for the coming months. The simple vision of an economic slowdown followed by a rapid rebound as monetary policy is eased, is coming apart. Time will tell what emerges from this noise, but it will likely take many weeks. Eventually, old and new investment styles will emerge to map the next few years. First though is risk management. Second comes finding the right entry points for this would-be future, but bottom-fishing is a very difficult task, suggesting patience with proper selection should still win the day.
The time of risk management
Risk management as you know is the art of reducing portfolio risks without losing returns. In essence, it is the art of finding the optimal portfolio on the curve linking returns with risks. The choice of the optimal portfolio within this continuity is one of each investor’s preference for defensive or aggressive portfolios – in essence a choice of the targeted volatility in the portfolio.
In its more advanced version, risk management is the art of positioning a portfolio as a function of different mechanisms such as the growth & inflation mix and old and new styles/factors. These emerge at different times and for different durations. Risk management (rather than just control) is also a function of the ability to anticipate the reaction of central banks and governments in driving sometimes uncertain/complex growth dynamics.
In a world where the mix of growth & inflation is quite uncertain with shocks arising now (especially in China) and likely well into next year, the art is to find attractively valued solutions with lower downside risk that are resilient across a multiplicity of scenarios & styles. Equities that have low beta bottom-lines and that combine attractive valuation and strong resilient fundamentals generally referred to as Quality – such as Air Liquide/Coca-Cola/Pfizer – are one such example. They typically have pricing power and offer goods that are resilient or necessary in a downturn. An ESG context generally helps to select companies that are better managed and more resilient in a downturn. Other solutions that fit these criteria would be Covered Bonds and certain capital preservation-focused multi-asset solutions.
The market has lived in the illusion of certainty while experiencing a set of complex shocks with the odds of a sharp slowdown or recession still unquantifiable. What we can strive for is to manage these complex risks and begin to position for the next few quarters at the right valuation. In this context, Low Risk/Quality stocks with attractive valuations and Covered Bonds with limited duration (or not) are of interest. Covered Bonds offer some yield and much safety.