07 September 2016

Not all doom and gloom for multi-asset investors

Intended for pension professionals. Not to be distributed to or intended for pension scheme members.

With the pound falling and forecasts of recession abounding, it's easy to be downbeat about the UK. But it's important to separate Brexit's short-term economic impact from your long-term financial goals.

Amidst all the doom and gloom in June, Legal & General Multi-Asset Fund actually delivered positive returns for investors.

Challenging times for the UK

Economic forecasting is tricky at the best of times. And in the face of a largely unexpected referendum outcome, the UK now faces considerable economic uncertainty.

In our central case, and despite recent news of resiliency, we still expect the UK to experience a mild recession in the second half of this year, after what was a relatively strong start to 2016.

The recent fall in the pound is likely to push up import prices and cause inflation to rise. Combined with some job cuts, this could lower the real-world value of incomes and cause consumer spending to fall.

In addition, the 'confidence shock' resulting from uncertainty about the future could reduce companies' short-term desire to hire new employees and spend.

The longer-term outlook is even less clear and depends on the type of future relationship the UK has with the rest of the EU.

We currently expect a relatively favourable deal to be struck, including free trade in services in exchange for minor limitations to movement of labour and less political influence in Europe.

Hardly a sterling outlook

We believe that sterling's decline is a function of the increased uncertainty, as this makes estimating a fair value for the pound difficult.

Without an anchor, the pound could struggle to stabilise until there is more hard data on the impact of Brexit on the real economy, or more visibility on the new relationship between the UK and the EU.

The UK is running a large current account deficit (i.e. the sum of our net trade and net foreign income is negative), the financing of which relies on continuing material capital inflows. With Brexit likely to have a negative short-term impact on foreign direct investments into the UK, these inflows could slow.

Given our central economic outlook for weak short-term UK growth and the potential for disruption in capital flows into the UK, we believe that more weakness in the pound is to be expected. However, we do not expect sterling to trade sustainably below 1.20 to the US dollar.

Positive returns from diversified portfolios

Yet the UK's challenges aren't necessarily bad news for investment portfolios that are globally diversified. This is because the positive impact of foreign currency exposure can be quite large if the pound is weak.

For instance, if the US equity market falls by 5% and the US dollar rises by 10% versus sterling, then a UK investor sees a positive return of 5%. Understanding this relationship is key given our expectation for the pound's value to remain volatile.

Thanks to significant foreign currency exposure, investors in Legal & General's Multi-Asset Fund have enjoyed positive returns both before and after the referendum result, highlighting one of the key reasons why we believe the fund has been picked as the main default fund for a number of DC pension schemes and lifestyles.

Furthermore, no asset class used in the Fund generated negative returns over the second quarter of the year overall, with investments in global real estate, infrastructure and UK index-linked bonds providing a particular boost for returns.

In the short term, we believe that an allocation to non-sterling assets continues to provide a suitable protection strategy for UK investors. Furthermore, by remaining diversified across several different asset classes, we believe we can seek to reduce portfolio volatility for investors in the Multi-Asset Fund and keep their investments aligned with their attitude to risk.

Investors can also rely on the flexibility of Legal & General Investment Management's multi-asset approach to focus on areas that we perceive to be most attractive from a risk/reward perspective.

For example, today's environment of low interest rates, but not excessively weak global growth could be good for 'medium-risk' assets such as emerging market debt and global real estate. Both asset classes have limited European exposure, but could benefit from central banks' desire to remain supportive.

Focus on your investment goals

So it's not all doom and gloom for investors. Although difficult, it's important to look past any short-term economic noise and to focus on the risk adjusted returns that a globally-diversified portfolio can deliver, even during a period of market volatility. We believe this demonstrates the benefit of remaining diversified across different regions and asset classes, and that investors should remain focused on their long term investment goals.

Past fund performance is not an indicator of future performance. Risks associated with our funds are listed in the relevant fund documentation.

The views expressed in this article are those of Legal & General Investment Management.