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Regime change - the investment implications

The key investment themes that arise from the end of the QE-era, and at least partial reversal of globalisation, are complex.

In the words of Fed Chair Jerome Powell, central banks are effectively unwinding their ‘short volatility position’. A higher-volatility market regime creates opportunities as well as risks for investors. Somewhat paradoxically, the diminished influence of common global macro drivers – QE and globalisation – increase the value of globally diversified investment strategies.

 

QE SUPPRESSED VOLATILITY (VIX INDEX)

Source: ECB; Federal Reserve; European Central Bank; Bank of Japan; and BlueBay estimates and projections; latest actual monthly data for September 2018

Responsible investors are adapting to the challenges posed by greater political uncertainty and climate change by incorporating environmental, social and governance (ESG) factors into their investment process.

Investments that ignore environmental and social ‘externalities’ with a sole focus on financial profit and loss are unlikely to be sustainable and face much greater political risk and government intervention.

Ignoring ESG not only places investors’ capital at greater risk but also precludes return opportunities that arise from the mispricing of ESG-related factors

 

Investors must look beyond QE-diminished beta for alternative sources of return and diversification for their portfolios.

Macro drivers dominated asset returns in the QE-era investment regime, characterised by high asset correlations and low volatility that favoured benchmark-tracking approaches solely targeting beta returns.

In the QT regime, micro factors – country, sector and issuerspecific issues – become more important, favouring active investments based on fundamental analysis of idiosyncratic risks. In addition to a greater emphasis on ‘bottom-up’ security selection, greater volatility and tactical asset allocation can also be a source of additional returns.

 

“In our view, the multi-decade trend of falling inflation and interest rates is over. Political as well as financial catalysts for market volatility abound.”