investment viewpoints
Investing in 2022, a year of regime change
Like financial risk, change can also cluster. Revisiting our CIO views published over 2022, we consider the seismic shifts in the investment landscape and how our strategies adapted dynamically to the new environment to make the best of it for investors.
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A new reality
Everything changed in 2022. Peace turned to war in Ukraine, precipitating food and energy insecurity globally. Prices rose sharply worldwide from the commodity shock, supply-side constraints and pent-up demand as pandemic-induced constraints lifted. The decades of rates being low-for-long mutated, seemingly overnight, into rhetoric of higher for longer. Geopolitical uncertainty spread while hopes for a post-Covid bounce gave way to concerns about long-term growth.
We look back at the journey to this new reality, delving into three key areas: the resurgence of inflation, the energy crisis hastening the sustainability transition, and volatility sparking opportunity.
Throughout a tumultuous year, our CIOs across asset classes chronicled their investment guidance, addressing how to adapt portfolios to be more defensive and becoming more opportunistic when conditions merited this.
Inflation surges, and persists
The year 2022 will be remembered as the year inflation proved persistent, as global price rises ushered out the era of low-for-long rates and definitively raised the cost of capital. Even as the main Western central banks steadily raised rates, inflation proved stickier than expected, leading to speculation about how policymakers would balance tackling inflation with fostering growth.
Throughout the year, our CIOs assessed this inflation fixation. They even considered the contrarian question of whether inflation concerns were over-inflated. Amid general agreement about the market entering a cycle of structurally higher inflation, our CIOs looked beyond the headlines to find areas of compelling valuations for investors, seeking out where dislocations from the undifferentiated sell-off had created opportunities for active managers. Building resilience into portfolios was a key focus, using defensive positioning to both protect and generate better risk-adjusted returns.
Considering attractive entry points in US and European fixed income, our bond specialists tracked how the regime change from low-for-long was making bond valuations increasingly attractive for the first time in years. They also noted that the market conversation was shifting towards growth, as part of the inflation versus growth standoff that drove much of the uncertainty in 2022.
An energy crisis hastens the sustainability transition
In the early months of 2022, Russia’s invasion of Ukraine unleashed higher commodity prices that spurred inflation as well as an energy crisis. The conflict also raised key questions about the transition to more renewable energy sources, not to mention the link between sustainability and inflation. This led to a new impetus behind the energy and food transitions, boosting the case for investment in companies focused on building a more resilient and greener future in these systems.
With uncertainty at an all-time high, our stock-pickers looked at how the Russia-Ukraine war could impact equities. They stressed the importance of investing in high-quality companies with strong financial and sustainability credentials, in addition to exposure to secular growth opportunities. This focus on high-quality names would become a persistent theme throughout the year, adding robustness to portfolios.
By asset class, our CIOs considered how war and inflation shaped the outlook, highlighting the advantages of active investing by making qualified choices based on thorough analysis and proprietary research. The environment clearly required resilience in portfolios, too: from convex strategies in multi-asset to the inherently lower exposure to inflation in convertible bonds, to the potential for relative-value plays in alternatives.
The clouds did not only gather because of war: they also signalled the growing focus on the urgent need to decarbonise the economy. In Europe, our CIOs saw opposition to Russia accelerating the transition to renewable energy amid a geopolitical shift to reduce dependence on imported oil and gas. Our sustainability research found that the energy transition – by gradually shifting reliance away from fossil fuels – could in fact be expected to play a stabilising role over time and reduce the long-term cost of energy (or electricity, more specifically).
Volatility generates opportunity
Change and volatility are often bedfellows. Drawdown came into sharp relief during 2022, battering markets with pronounced moves that also opened windows of opportunity. Throughout the year, our CIOs sought alpha in uncertain (and choppy) markets: from making sense of high levels of dispersion in January, to finding pockets of value in dislocated markets in the summer, to being mindful of under-appreciated extreme scenarios in the autumn.
Throughout, our ethos of being rethinkers informed our CIOs’ perspectives as they sought hidden opportunities representing value for investors while avoiding over-crowded (and often over-hyped) positions.
We kicked off the year by turning volatility’s downside up. Rather than becoming embroiled in the early debacle over the value-to-growth rotation in stocks, our CIOs considered instead how to capture alpha from both areas based on strong fundamentals and favourable exposure to long-term trends. The quality theme was clearly entrenched.
Questioning how to stay diversified when volatility rises, our multi-asset team explained methods of staying long, sharp and diversified in a bearish rotation. Amid a continued rise in real rates and looming risks, they advised varying exposure to equities and saw value in tailored, derivative-based solutions, such as using long-volatility strategies for their defensive characteristics.
Bears and beyond
As bears firmly steered markets mid-year, we took a more medium-term outlook to consider the silver linings to the clouds. For instance, valuations in fixed income were looking attractive in a theme that would gather traction, while our equity selections focused on companies able to self-fund their expansion, and which are more likely to have resilient valuations.
Pricing dislocations in convertible bonds made them more appealing to corporate-debt specialists, providing ample fodder for explaining why convertibles make sense for credit investors. Our convertible bonds team found an advantageous technical configuration whereby a significant part of the universe became dislocated and overlooked after an indiscriminate sell-off that did not take into account companies’ profitability or need to refinance. By adopting a defensive stance, carefully managing equity sensitivity, keeping a lower duration than the universe and being disciplined in respecting entry and exit points, the team outlined ways to embed resilience into portfolios.
Extreme scenarios
In the following months, soaring energy prices and continued uncertainty about the inflation-growth trade-off meant drawdown remained baked into markets. By the end of September, massive gyrations in UK gilt yields followed the former Prime Minister Liz Truss’s mini-budget as it precipitated margin calls for pension funds engaged in liability-driven investing.
The episode perfectly illustrated the impact an outlier scenario can have when it lands on an illiquid market priced for consensus, making our call to be prepared for unforeseen tail risk particularly salient. By asset class, our CIOs' views considered how embedding hedges and stressing true diversification could favourably position investors in case of an unlikely hit. Tactics included lowering duration risk in fixed income to finding cheap optionality in alternatives.
In preparing portfolios for the unexpected, our alternatives and multi-asset teams examined the importance of taking extreme scenarios into account and adapting dynamically as circumstances change. Using stagflation as an illustration, they emphasised the under-appreciated value of cash and how putting a weight on all possible outcomes necessarily alters allocations.
Resilience in the face of change
The investment regime may have changed in a year, but our ethos remained constant: we believe in holding strong convictions while acting flexibly and nimbly to strive for optimal positioning. Our CIOs moved beyond well-telegraphed binary outcomes, building on quality and other asymmetric properties instead that helped our strategies play both defence and offense, and ensured much-needed resilience when uncertainty abounded.
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