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If interest rates are cut in the absence of a recession (the current central case), the rate cuts will provide stronger support for investment performance. Historically, easing cycles in growing economies have led to most asset classes rising in the 12 months following the first rate cut, with the exception of commodities (Display 2, bottom).
Some diversified investors perform better in certain environments, such as hedge funds or trend strategies. Trend-following strategies have historically performed better during economic downturns because they are designed to protect portfolios during economic downturns. Because hedge funds have the lowest correlation with other assets, they typically perform better when markets are not stressed, which is why they outperformed during periods of non-recession-related interest rate cuts. We believe that this behavior and the low correlation between these assets and other alternative assets allowed us to increase the risk/return of our diversification strategy.
Embracing the “less exceptional” with a multi-asset approach
Extreme inflation, interest rates, and monetary policy have led to a roller coaster ride through 2023 for most asset types. Recent data shows that markets and the economy continue to normalize, and the investment environment historically tends to improve relatively quickly once interest rates peak.
Bonds have rallied recently as yields have fallen and prices have risen, but there still appears to be room for investment. However, given the lingering interest rate uncertainty, investors should be cautious when adding duration exposure. I also like the outlook for risk assets such as stocks. The market in 2023 soared in a narrow group of seven stocks, but should benefit more broadly from lower inflation.
From a big-picture perspective, moderate economic growth is expected in 2024, but that is not a given. This means multi-asset investors need to be nimble in responding to changing market conditions, which may include longer interest rates and some surprises. Given how the asset behaves differently in two different environments, we believe that active diversification has the potential to improve performance no matter which scenario unfolds.
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