Capital markets have been experiencing an historic run, accompanied by significant bouts of volatility. But the investment backdrop is growing more uncertain and distorted.
In this context, many investors, while still wishing to deliver against their risk and return objectives, are seeking to diversify and derisk their exposure. Some may find the answer in alternatives and more illiquid investments, including private equity, private debt and hedge funds. However, many asset owners, remembering the global financial crisis, are likely to be concerned about excessive leverage and the opacity of certain more esoteric investments.
“U.S. equities, as represented by the S&P 500 index, have posted annualized returns of around 15% over the last decade, while valuations have become ever more elevated,” said Suzanne Hutchins, investment leader of Newton Investment Management’s Global Real Return team. “The cyclically adjusted price-to-earnings ratio has been above 30 for much of the last two years, a level not seen since the dot-com bubble in the late 1990s to early 2000s. Such asset-price inflation has not been limited to equities, with corporate bonds and high-yield credit among other asset classes that have experienced similarly robust returns over the same period.”
In addition, she said, the global economy is highly indebted and the productivity of new debt (measured by the amount of economic growth generated by each incremental increase in borrowing) is falling as capital is increasingly misallocated. Further, major economies around the globe are cyclically challenged, particularly in the area of global trade, with frictions and pressure on supply chains intensifying.