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Michael Sager. I’m vice-president, multi-asset and currency at CIBC Asset Management.
At the end of February/beginning of March 2020, as the Covid outbreak really intensified in North America and we saw widespread shutdowns across the global economy, it was really important to do two things. First of all, to play defence with your risk budget to make sure that alternative strategies perform differently to the core portfolio, the core equity-bond portfolio of investors. So that meant equities were under stress particularly, so play defence with alternatives, reduce risk. But also shift positioning into assets and strategies that were likely to outperform. Some examples of that were to increase long exposure to gold. Gold is a safe haven asset and over stress periods broadly, gold tends to outperform — not always, but it tends to. So increase gold positions. And then increase hedging or insurance positions: positions that are able to benefit when market volatility spikes, or when equity markets go down, so option insurance strategies. I think the important thing was to have flexibility and to use that flexibility to direct your risk budget into strategies where conviction was highest. And those typically were defensive strategies.
The changing market environment — the improving market environment — has led to us increasing our risk. We see more opportunities — more value opportunities, for example — better risk sentiment, so our investment conviction, in a wider sense of our investment strategies, has increased. The first decision that we’ve taken over the last several months is to increase the amount of risk that we’ve deployed to exploit the broader set of opportunity. But secondly, we’ve also shifted from a more defensive stance to one that’s more pro-cyclical.
As risk markets become more constructive, as the cyclical economy has gained momentum and broadened out, so the opportunities to benefit from a pro-cyclical stance have improved. All of that doesn’t mean to say that it’s time to eliminate all defensive strategies and positioning from portfolios, the question more is the balance. And we found that relatively more risk in pro-cyclical with the residual exposure still to defensive and safe haven strategies made a lot more sense during the spring and the summer recovery.
We would characterize our outlook as cautiously optimistic. We’re optimistic that given the broadening out of the global cyclical recovery, given the amount of liquidity in the global economy right now, and a number of quarters to come, and given prospective progress on a Covid vaccine, there’s reasons to be optimistic. As I said, it’s cautious optimism so there are also a number of risks.U.S. election risks: Who will win? Will it be a clean sweep of all the arms of the government? What does that imply for policy?
Geopolitical risk broadly has subsided a little bit as we move through 2020, but it’s still there, it’s still important. We have to be cognizant of that. And Covid risks are still very significant. We’ve seen significant pickup in the incidents of infection or infection rates in Europe, for example, with more restrictions on movement brought in in the U.K. in the middle of September, for example. So all of these are important risks. Uncertainty prevails about the long-term outlook for inflation. At the moment, inflation risks are clearly on the downside and the Federal Reserve and the European Central Bank in September both indicated that they’re unlikely to achieve their target rate of inflation before 2023.
But further out, looking up to a 10-year horizon, the risks seem to be skewed a little bit to the upside on inflation. What does that look like? So all of these are reasons to be cautious, reasons to think about risks within a broadly optimistic view of the world. It’s important to recognize that although markets are broadly positive — equity markets particularly have come a long way since the middle of March — which means that opportunities are more selective. You have to be a little bit more discerning now in your allocation across pro-cyclical opportunities.
So all of that says that it is a relatively good cyclical outlook, but lots of risks prevail. And it means that being exposed to equities broadly and EM credit broadly makes a lot of sense, particularly in those markets where value opportunities persist and in EM credit fundamentally attractive carry opportunities persist. But it also means that defensive strategies are sensible.