Investors turn to diversification and hedging strategies as economic uncertainty looms
Australian markets strategist, Saxo Bank
Summary: With economic uncertainty becoming the new normal, multi-asset trading is a way for investors to hedge risks and heighten returns.
Increasing economic and geopolitical risk is fuelling the rise in multi-asset trading as a way for investors to hedge their risks and heighten returns in an increasingly volatile marketplace. Traditionally, investors have tended to trade one asset class a time however they are increasingly ‘hedging’ their positions across multiple asset classes, being nimbler and focusing not just on capital returns but capital preservation too. This is because a diversified portfolio reduces risk by not being concentrated in one specific area of investments, one of the most important principles in investing. A diversified portfolio allocates capital across different asset classes such as cash, fixed interest, property, domestic and international shares, as well as within asset classes, e.g. industry sectors, in order to reduce overall investment risk.
As a pioneer in multi-asset trading, we have noticed this trend first hand that traders increasingly trade across different asset classes and geographies because assets tend to rise and fall at different times, if investors have exposure to a range of assets. A fall in one will likely be balanced out by an increase in another, thereby helping to minimize losses and provide a more stable overall return, a key benefit of diversification and important component of managing risk and reaching financial goals. Therefore, maintaining a diversified portfolio is essential to any long-term strategy. It’s easy to see why investors are adopting this strategy when you look at today’s trading environment, which is continually being met by unprecedented challenges for even the savviest trader.
While the US economy is faring relatively well to date, there are worrying signs such as reduced spending on consumer durables as well as a divisive political landscape. Crossing the Atlantic, we see weakness across the Eurozone, with Germany, once an economic powerhouse, experiencing a major manufacturing slow down. And Germany is not alone. Developed economies such as France and Italy are beset with their own economic weakness. Then we have the uncertainty around Brexit to cause further market unease. This confluence of factors has created a scenario where traditional investing strategies no longer work. With returns lower and volatility higher, portfolio diversification will be the name of the game for the rest of 2019 and the foreseeable future. This is particularly important as we enter the summer period which tends to be characterised by high volatility.
Another reason why investors feel more comfortable venturing into multi-asset investing is the availability of analytics. On our platform, SaxoTraderGO for example, investors can review how their portfolio is performing both on aggregate and at instrument level across the different asset thresholds, enabling investors to monitor impact of potential trends and growth sectors such as electric vehicles, battery technologies, renewable energy and the like and then make investment decisions accordingly. The platform also provides easy access to multiple indexes, ETFs and mutual funds so even less experienced investors can easily diversify their portfolios.
While multi-asset trading won’t provide protection during a total market collapse, risk can never be completely eliminated, Diversification can mitigate asset-specific risk and volatility which will help cushion investors against many of the worst shocks, much more so than using a strategy that focusses on one asset, e.g. currencies, equities, property. It also allows investors to better identify and map a slowdown in particular sectors and then move to adjust the portfolio to a larger weighting in assets that might be performing better.
But multi-asset trading is not just about adjusting portfolios against risk. Many sophisticated institutional investors including pension funds, investment managers and banks are also seeing the benefit of multi-asset trading desks as a way to consolidate and reduce internal costs in addition to providing a more efficient way to comply with increasing regulations. This has come as a result of investors finding it easier to keep abreast of new regulation via one single trading platform, rather than monitoring trading across different platforms. In this respect, retail trading and investing has led the way.
Technology needs to play catch up
The growing demand for multi-asset trading however will force a rethink in how trading desks are organised. Instead of a set of specialists, trading and investment providers will need to create multi asset trading desks with experts on a wide variety of asset classes, from equities, to fixed income to derivatives to cryptocurrencies. This will pose considerable challenges to create front office systems that can enable cross-asset class functionality, and a re-examination of staff recruitment to include those with broader knowledge of multiple asset classes. Along with these changes will be the need to ensure continued transparency and disclosure, showing risk across portfolios for clients and other stakeholders.
With economic uncertainty becoming the new normal, multi-asset trading will provide both challenges and opportunities for firms who are prepared to invest in and adapt their internal trading systems in order to stay competitive and meet new client demands.