Author: NN Investment Partners
Focus on downside risks led to a sudden demand for safe and liquid assets as well as to a substantial increase in risk premia. We adopt a cautious asset allocation stance.
Since the start of the year markets have been in a state of turmoil and we have witnessed a substantial increase in risk premia across the board. This is consistent with an increased demand for safe assets by global investors.
In 2008, the near-death experience of the global financial system installed a good deal of “dread risk” in the minds of global investors, which essentially meant an excessive focus on the downside risks. Since early 2016 this dread risk has returned to the forefront as markets started to focus on the complex interaction between weak emerging world growth, falling commodity prices and volatile exchange rates. The common element among all these factors has been growing recession fears and a sudden demand for global safe and liquid assets.
The most important antidote to such dread risk is a confidencerestoring policy response. In particular, monetary policy can reduce risk premia directly by injecting more liquidity into the system and indirectly by sending the signal that unlimited firing power will be used if necessary. Amid the recent turmoil in financial markets, central banks have come again to their rescue and pledged to do so again in the future. As a result, a mild form of search for yield could well establish itself again, favoring spread products at large.
In theory, risky asset classes should find some support from the attractive valuations, exaggeratedly negative sentiment, easier monetary policies and positive earnings surprises. Investors are however not yet fully convinced about these positive factors and remain concerned that substantial headwinds continue to linger, such as a very unbalanced global economy. Adding it all together we decided to adopt a balanced and cautious allocation stance. This means that we have a neutral stance on equities, real estate and spread products. We maintained an underweight stance on commodities and became underweight treasuries.