The importance of getting the asset allocation decisions right has long been engrained in the thinking of investors and financial professionals. The difficulty has been how to get outside the realm of the subjective and have an approach that delivers consistently. A large body of academic research - much of it by my partners and co-founders of Parala - has long identified that understanding the state of the macro-economy and how it is evolving can be very useful in determining investment asset returns. At Parala, our combined skills and pioneering insights on financial market behaviour has resulted in a state-of-the-art investment methodology able to forecast the movement of security prices by modelling the correlation of macro-economic variables to individual assets and to factors that have been shown to drive market performance. The methodology is distinguished by its ability to learn and adapt across time and to quickly respond to fast-changing landscapes. It underpins the multi-asset solutions we provide for our institutional clients and the funds we advise.
Parala's approach is straightforward and intuitive but one which requires highly complex and proprietary calculations to execute effectively. We've found that a simple way of expressing changes in expected investment outcomes is to use heatmaps. The heatmap below covers nine major asset classes. It shows a three-month ahead view of expected performance from April 2018 as well as the previous forecasts over the last year. Forecasts are updated each month with the latest macro-economic and risk factor changes.
What are our models telling us about key developments across asset classes for the coming months? A good place to start is considering some of the key macro trends that we have recently observed:
USD currency continued to decline on a trended basis against major trading partners.
Short term interest rates continued to rise which is negative for fixed term assets.
Economic growth is positive as indicated by year over year increases in commodity prices albeit at a slowing pace.
Default spreads increased while term spreads tightened which may be indicative of investor concern.
These macro variables and many others are part of the information set we use to generate forecasts which can then be distilled into rankings and the heatmap below. A nice thing about the table is that it can be used to assess the relative attractiveness of different asset classes at a point in time as well as trends in individual asset class expectations across time with the more attractive potential returns moving from red to green.
So, what are the observable trends and what might we expect in terms of asset class relative returns over the next three months?
Here are some takeaways:
Diversified commodities have the most favourable ranking over the coming 3-months followed by emerging market equities.
Among fixed income asset classes, sovereign bonds have the most favourable ranking and corporate bonds the least favourable.
Developed market REITs are the least favourable area to invest.
This month we also take a deeper dive into natural resources and real asset sectors.
What are the key market movers and what can we expect from natural resource and real asset sectors over the coming three months?
Despite recent market volatility, the three months ahead rankings of natural resources and real asset sectors have remained surprisingly stable.
Energy commodities have the most favourable rankings followed by industrial metals.
DM REITs have the least favourable rankings and listed infrastructure is the next least favourable.
Our state-of-the-art investment model is constantly learning and adapting to changing macro-economic and market conditions. Next month, we will provide an update to our three-month ahead view and take a deeper look into another asset class.