Just prior to one of the most challenging years in history for multi-asset investors, Goldman warned that with stocks and bonds both trading rich against an increasingly foreboding macro backdrop defined by a worsening growth/inflation mix, a “lost decade” loomed.
Subsequently, equities de-rated sharply on their way to a grinding bear market, while bonds suffered a historic rout that drew the curtain on a four-decade bull market.
At one point, 60/40 portfolios were down more than 25%, before trimming losses to end the year down around 17%.
For risk parity strategies, 2022 had no precedent. Bonds were the sponsor of last year’s market turmoil, and the accompanying surge in rates volatility was a story all its own.
“Given the logic of tightening cycles as periods of decelerated growth, the explosion of (rates) volatility was last year’s most outstanding anomaly,” Deutsche Bank’s Aleksandar Kocic said. “Irrespective of the metric one uses, rates vol appears excessive.”
As I put it in September, “previously docile bonds, domesticated by decades of structural disinflation and a dozen years of forward guidance, become lawless, and difficult to tame.”
The chart on the left plots rates vol versus a weighted composite of risk premia measures across markets — rates vol is disconnected. The chart on the right shows rates vol in units of VIX. Note the glowing green lines and the juxtaposition with the glowing orange line overlaid on the current hiking cycle.
“In previous tightening cycles, the ratio of rates/equity vol was always declining, or was at least stationary — as the path of rates became predictable while brakes on growth put more constraints (lower limit) on risk, rates vol declined faster than its equity counterpart,” Kocic went on to say. “In contrast, in the current cycle, the continued bid for rates vol against a steady or mildly upward trend in equities vol pushed their ratios higher.”
I should note that the first two figures above (the 60/40 and risk parity charts) assume simple allocations. It’s necessary to make some simplifying assumptions when you’re trying to make a general point. Given their bond Overweight, simple risk parity strategies labored through the worst year in six decades.
None of that’s to say that all multi-asset investors had a terrible year, or at least not relative to simple proxies like those illustrated above. In fact, thanks to diversification into, for example, shorter-duration fixed income, value stocks and, naturally, real assets like commodities, large multi-asset funds in the US outperformed simple 60/40 portfolios at a rate rarely witnessed over the past three decades. And macro funds rode trends to very solid performance in 2022.
“2022 was not necessarily as bad for the multi-asset fund management industry,” Goldman analysts led by Christian Mueller-Glissmann remarked. “While AuM-weighted performance was the worst since the GFC, most of the largest US multi-asset funds have managed to outperform… pointing to increased value of active multi-asset portfolio management.”
So, where to from here for multi-asset investors? Well, the good news for simple 60/40 portfolios is that the bear market in equities and 2022’s egregious drawdown in bonds means the longer-term outlook is better. Goldman’s “lost decade” was brought forward.
The bad news is, “better” doesn’t necessarily mean good. “Based on valuations alone, which are still elevated in a long-run context, the prospective real return for a 60/40 portfolio in the next 10 years is only 1.7% p.a.,” Mueller-Glissmann went on to say, adding that if you assume a return to 10% dividend growth and 2% inflation, Goldman’s 60/40 real return model “now suggests prospective real returns of around 5.5% p.a., near the long-run average.”
He was quick to concede that a return to any kind of benign macro regime could be wishful thinking. “Of course, macro conditions may not be as favorable as last cycle,” he wrote. “Peak inflation is supportive for 60/40 portfolios, but only if growth holds up and central banks stop tightening.”
