{"id":63217,"date":"2023-09-19T22:18:11","date_gmt":"2023-09-20T02:18:11","guid":{"rendered":"https:\/\/ifintechworld.com\/news\/where-to-add-risk-in-multi-asset-portfolios-right-now\/"},"modified":"2023-09-19T22:18:16","modified_gmt":"2023-09-20T02:18:16","slug":"where-to-add-risk-in-multi-asset-portfolios-right-now","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=63217","title":{"rendered":"Where To Add Risk In Multi-Asset Portfolios Right Now"},"content":{"rendered":"
\n

<\/picture>
<\/figcaption><\/figure>\n<\/p>\n

By Tom Nelson, CFA, Head of Asset Allocation Portfolio Management, Franklin Templeton Investment Solutions; Miles Sampson, CFA, Lead Asset Class Analyst, Franklin Templeton Investment Solutions; and Spencer Walling, Research Associate, Franklin Templeton Investment Solutions<\/em><\/p>\n

While some stocks may seem expensive, there are areas of opportunity that feature attractive valuations and growth catalysts, according to the Franklin Templeton Investment Solutions team.<\/span><\/em><\/p>\n

Are investors too optimistic?<\/strong><\/h2>\n

In some regions, including the United States, the macro backdrop has been improving. Growth remains resilient, with strong service sector activity and a stabilizing manufacturing environment.<\/p>\n

Inflation continues to abate, with inflation surprises near three-year lows. Federal Reserve (Fed) policy is restrictive, but the odds of \u201cpeak Fed\u201d rates have grown substantially over recent months. Overall, the probability of a soft landing has certainly risen.<\/p>\n

How are asset prices reacting to this news? Risky assets – such as equities and high-yield credit – did not wait for the \u201call clear\u201d sign from macro-land. Their rally began nearly a year ago in October 2022 at the first signs of a peak in inflation, but well before a substantial improvement in growth or monetary policy. Most equity markets have achieved bull market status, while corporate bond spreads are near cyclical tights.<\/span><\/p>\n

The challenge today is that most risky assets have rallied ahead of both the current and projected macro environment (see Exhibit 1). In our view, most risky assets are pricing in macro expectations that are overly optimistic. While the macro backdrop has improved, we still believe there is considerable uncertainty over what lies ahead next year.<\/p>\n

Exhibit 1: Risky assets are overly optimistic<\/strong><\/em><\/p>\n

\"Risky<\/span><\/p>\n

The mispricing of risky assets is a key reason why we remain slightly defensive at the portfolio level. We favor fixed income over equities, where it is now relatively easy to find high-quality bonds yielding over 5% with little duration or credit risk.<\/p>\n

Where to add risk in multi-asset portfolios<\/strong><\/h2>\n

While most global equity markets have rallied since last October, not every index has performed equally. We examine equity pairings that historically perform well when growth is beginning to improve from below-trend levels, which is the environment many regions are in today (see Exhibit 2).<\/p>\n

While some parts of the equity market have performed well – cyclicals and growth stocks – other parts have lagged considerably, namely US small caps and emerging markets.<\/p>\n

Exhibit 2: What Has Outperformed During the Most Recent Equity Rally?<\/strong><\/p>\n

\"What<\/span><\/p>\n

It is not hard to rationalize why these equity markets have lagged.<\/p>\n

US small cap stocks are generally more sensitive to higher interest rates, due to a larger amount of variable rate debt and weaker balance sheets (i.e., lower interest coverage ratios).<\/p>\n

Plus, exposure to the artificial intelligence (AI) theme and the \u201cmagnificent 7\u201d group of technology stocks is much more limited within small caps. In emerging markets, China\u2019s economy continues to struggle for momentum, and more broadly, we have observed a weak global manufacturing environment.<\/p>\n

The good news is that these risks appear to be largely priced in. Valuation ratios, like price-to-earnings or price-to-book, suggest these assets are attractively valued. However, valuations are not good tactical indicators.<\/p>\n

Therefore, we identify some key catalysts that are developing in support of US small caps and emerging market equities that we believe markets have yet to fully reflect.<\/p>\n

US small caps<\/span><\/em><\/p>\n