Navigating volatility – The appeal of diversified returns in Global Real Return

The investment environment has changed significantly over the past five years, shifting from low interest rates and stable inflation to a period of high inflation and aggressive central bank interventions. CPI inflation rose to 40-year highs² across developed economies. Consequently, central banks’ interest rate hikes and process of balance sheet normalisation (quantitative tightening), culminated in a savage bond market sell-off.

Volatility and market dynamics

Many clients increased their allocation to more illiquid assets such as private equity and credit during this period, often positioning such strategies alongside a long-standing fixed income allocation, the latter representing the bedrock of their investments. While the shortcomings of a standalone allocation to illiquid assets with limited transparency could well be exposed should the tide roll out, fixed income is likely to still have a place in a well-diversified portfolio. However, many have not fully appreciated the extent to which the volatility of bonds has exceeded that of equities.

Between the start of 2021 and end of 2024, bonds exhibited greater volatility than equities 85% of the time.³ September 2022 and August 2024 were noteworthy exceptions: these two periods saw equities show higher volatility, driven by inflation peaking in the US and weak US economic data respectively. Nevertheless, the over-riding trend of heightened volatility from fixed income markets prevails. Based on these observations, it may make sense to combine a fixed income allocation with a strategy displaying a more constrained volatility profile.
 

The potential volatility of the bond market due to elevated levels of debt in developed economies is another consideration. More government intervention means that fiscal prudence may diminish, heightening the risk of market turbulence as bond market vigilantes become increasingly spooked by sovereigns’ stretched finances. It is also worth noting that corporate bond spreads are at historic lows.

Agility and adaptability

So what investment solution is needed to optimise performance in such an unpredictable and fast-moving regime? The ability to protect the portfolio against market drawdowns is valuable, as is the ability to be agile enough to adjust exposures in the face of market shocks.

In early August 2024, the Global Real Return portfolio navigated the MSCI ACWI fall of -12.5% relatively unscathed, falling by just -1.1%. This was thanks to the significant equity market protection that had been accumulated relatively cheaply, when volatility was low. Furthermore, in 2020, during the COVID-19 crisis, the strategy adapted by buying discounted assets and increasing gold exposure, a move that echoed the 2008 financial crisis playbook.

The strategy has historically provided lower drawdowns than equities and bonds, sometimes even generating positive returns in volatile markets, as highlighted in the below chart.
 

Looking ahead

We are at an important juncture with the change of US administration. The decidedly pro-growth agenda could lead to fiscal stimulus, increasing inflation risks, which could impede a recovery in the US housing market. More generally, there are several risks including geopolitics, relatively inflated investor sentiment and government deficits at peak levels which give us cause to be prudent in our positioning. Artificial intelligence (AI) remains a key investment theme, but there is concern that valuations may be overextended. While we believe in the long-term trend, we are mindful of pullback potential.

Bonds will still have a role in portfolios but may need to be complemented by other stabilising assets due to a changing market regime. The new regime is more fragile, and the shocks of tomorrow will look very different in frequency, intensity, origin and ability to spread across the system.

Given market volatility, we believe a flexible, diversified strategy like Global Real Return, combined with a core fixed income holding, can increase the probability of a smoother ride while also gaining exposure to a broad range of return sources, many of which are uncorrelated to traditional assets.
 

Investment objective: To achieve a total return in excess of a cash benchmark over an investment horizon of 3-5 years. However, a positive return is not guaranteed and a capital loss may occur.

Benchmark: The Fund will measure its performance against 1 Month EURIBOR + 4% per annum (the "Cash Benchmark"). The Cash Benchmark is used as a target against which to measure the performance of the Fund over 5 years before fees. However, a positive return is not guaranteed and a capital loss may occur. EURIBOR is the Euro Interbank Offer Rate and is a reference rate that is constructed from the average interest rate at which Eurozone banks offer unsecured short-term lending on the inter-bank market. The Fund is actively managed, which means the Investment Manager has discretion over the selection of investments, subject to the investment objective and policies disclosed in the Prospectus.

Key investment risks

Objective/Performance Risk: There is no guarantee that the Fund will achieve its objectives.

Currency Risk: This Fund invests in international markets which means it is exposed to changes in currency rates which could affect the value of the Fund.

Changes in Interest Rates & Inflation Risk: Investments in bonds/ money market securities are affected by interest rates and inflation trends which may negatively affect the value of the Fund.

Credit Risk: The issuer of a security held by the Fund may not pay income or repay capital to the Fund when due.

For a full list of risks applicable to this fund, please refer to the Prospectus or other offering documents.

Please refer to the prospectus and the KIID before making any investment decisions. Documents are available in English and an official language of the jurisdictions in which the Fund is registered for public sale. Go to bny.com/investments