Multi-Asset: Alternative sources of diversification remain crucial

What’s your outlook for multi-asset in 2025, considering the key themes?

Asset classes will not be immune to volatility as we head through 2025, given the ongoing influence of monetary policy uncertainty, geopolitical risk, and election outcomes. However, the monetary easing cycle provides a key support for risk assets - if, and it’s an important if, the global economy does not enter a deep recession. While a recession remains a risk, evidence suggests that any slowdown is likely to be mild in nature and our base case is that a global recession will be avoided. Normally over the course of a cycle leverage in the private sector increases, but looking around the world today, except for a few places like China, we see relatively little evidence of financial imbalances or excess in the household and corporate sector. For many, including lower income households, balance sheets are in a stronger position than they have been in decades. In our view, this backdrop supports positive returns in equities and a higher interest rate environment supports the higher yielding instruments within fixed income. Across equities, we believe there will be rotation across sectors, size, and regions. From a multi-asset perspective, the risk of correlations shifting are an important consideration and so we believe multi-asset investors need to ensure they have alternative sources of diversification within their multi-asset toolkit.

What are some of the main areas of opportunities you’re seeing in multi-asset?

We believe that the US is likely to cut rates by less than is currently priced into markets but that is not a showstopper for equity markets. While the Fed may do less than is expected, we could see more from the ECB and Bank of England although cuts are likely to be gradual. While the Fed may cut less than priced, US growth currently remains resilient and importantly labour markets continues to be robust. We believe this combination of relatively stable growth and lower interest rates could act as a catalyst for rotation, both within the US equity market and across regions. Concentration risk is high in US large caps, and we believe performance will broaden out in 2025. This suggests a rotation from large caps to mid-caps in the US and a change in regional leadership. The UK equity market has lagged global equities and, in our view, provides a good valuation opportunity as asset allocators reconsider their exposure to US equities, and to the US dollar. If interest rates are on average higher going forward relative to the post-GFC period, higher income assets such as high yield credit and emerging market debt tend to outperform. Local emerging market debt could also benefit from a move lower in the US dollar.

Which sectors will you be keeping an eye on in 2025?

Technology has dominated sector performance over the past few years, but other sectors may be set to benefit from the changing macro environment going forward, leading to less concentrated sector returns. A higher interest rate environment would typically favour Financials and while technology led progress around the world is not set to disappear, a broad range of companies are now referencing the productivity gains from employing technology led solutions in their own practices. Consumer sectors must be a key focus for the health of the overall economy globally, capturing pricing pressures and changing labour market trends. Within the alternatives space real estate looks compelling from a valuation perspective and in our view could perform relatively well given the monetary policy backdrop.

What are some of the key risks, specific to multi-asset?

As we enter 2025, investors must consider how to manage risk against this macro backdrop. In multi-asset investing, the key is to maintain a diversification relationship between equities and bonds. A major factor will be how inflation unfolds in 2025. While inflation has moderated, any supply shocks that drive up goods inflation or strong demand that keeps services inflation at high levels will make it difficult for central banks to cut rates. With the market still assessing the outcomes of elections early in the new year, particularly related to fiscal budgets, fixed income volatility could remain elevated. It would be prudent for multi-asset investors to look for alternative sources of diversification to have in their toolkit. We believe commodities, real estate and where possible, other alternatives provide an important source of diversification while the correlation between equities and bonds is at risk of turning positive again.