Helping Meet Investor Challenges

Market Insights: Investment Strategy

Market Insights: Investment Strategy
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Capital Allocation in Current Markets

We believe that investors need to evaluate whether the perceived investment risks inherent in their asset allocations can be compensated for given the anticipated market environment. Of the risks typically faced by most investors, we focus on those that are most likely to adversely affect investors’ portfolios if left unaddressed.We approach this from the perspective that some investors seek to achieve a combination of sustainable income, long-term capital growth and/or capital preservation.

 Equity Indices

Strategy Implication: Nominal Interest Rate Duration

While it may still be too early to call the end of the three-decade bull market in interest rates, and while rates have fallen back somewhat in March, the balance of risks has clearly and meaningfully shifted to the upside. This is a risk that directly and indirectly permeates many elements of an investor’s portfolio through exposure to fixed income and other interest rate-sensitive asset classes. Unaddressed, rising interest rates can jeopardize both the income-seeking and capital-preservation goals of investors.

Possible Actions to Help Mitigate Interest Rate Risk

Include the reallocation of capital towards unconstrained multi-sector fixed income products, greater global fixed income market exposure, increased holdings of floating rate corporate debt/private debt, corporate credit, investment in laddered bond structures and other “hold-to-maturity” strategies.

MI_market_10yr_chart

Strategy Implication: Rising Inflation Expectations

Inflation is a silent killer. For investors whose portfolios are comprised predominantly of financial assets backed by nominal cash flows, such as coupons and dividends, inflation can erode the purchasing power of these cash flows and therefore impair the value of the financial asset supporting the cash flows. Inflation risk for now remains nascent; however, investors should consider allocating a greater share of their capital to assets with embedded inflation protection as we expect upside inflation risks to increase going forward.

Possible Actions to Help Mitigate Inflation Risk

Include greater exposure to real assets such as commodities and commodity-linked equities, Treasury Inflation-Protected Securities (TIPS), real estate and infrastructure. This can be achieved either through individual asset class exposure or via blended multi-strategy approaches.

MI_market_5yr_chart

Strategy Implication: Assumed Correlations

Proverbially referred to as the only ‘free lunch’ in investing, diversification, as an investment risk management tool, depends on its effectiveness on the degree of correlation between the asset classes and strategies that comprise investor portfolios. Typically, the greater the level of correlation across a portfolio, the lower the overall level of diversification. In and of itself, low or high levels of portfolio diversification represent neither desirable nor undesirable outcomes, as the context of the overall investment objective of the portfolio needs to be considered when making this assessment. For example, forgoing diversification in favor of certainty of income for an income-seeking investor may be an optimal trade-off.

Nonetheless, what remains paramount regardless of the investment objective is that, where diversification benefits are sought, understanding and managing the inherent variability in correlations is vital from a risk management perspective since diversification cannot assure a profit or protect against loss. The evolving policy environment has the potential to destabilize correlations both within and across asset classes relative to the recent investment environment. Incorporating this emerging risk into the design of a portfolio is an important consideration today.

Possible Actions to Help Mitigate Correlation Risk

Consider embracing a more dynamic approach to asset allocation to anticipate and manage the impact of unstable asset class correlations and volatilities. Investors should also exploit asset classes and strategies that have a structurally lower correlation relative to that of the incumbent asset in their portfolio in order to lower expected volatility without compromising on target income or return potential. Strategies can include certain alternatives and multi-factor-based investments that adopt different weighting schemes to help mitigate the dominance of equity risk in an overall portfolio risk.

MI_invest_return_chart

Strategy Implication: Uncompensated Market Risks

At a time of heightened policy uncertainty, with the possibility that left tail risks† dominate market sentiment, and with elevated market valuations for certain equity and credit markets, the preconditions for a correction in risk assets are firmly in place. This is not a forecast but simply a statement acknowledging the existence of risks that could adversely affect income-generating, capital growth and/or capital preservation goals. Investors tethered to these risks via their allocation to either passive strategies or active strategies which are closely managed relative to passive indices should consider adopting a more unconstrained active approach that seeks to avoid some of the drawdown risk implied by current market conditions.

Possible Actions to Help Mitigate Market Risk

Consider allocating to unconstrained active equity and fixed income strategies whose risk profiles can diverge significantly from their representative benchmarks. This approach allows for the possibility of limiting market-derived tail risk without necessarily giving up expected returns.

MI_market_Shiller's_chart

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Strategy Implication: Active Risk vs. Market Risk

The factors influencing the case for becoming more vigilant with regard to uncompensated market risks are also signaling the potential for a period of strong performance for active management. Currently, there is an emergence of conditions that we believe are necessary (but not sufficient) for active management success. After a prolonged period of elevated correlations and lower relative risks within and across asset classes, equity markets and sectors, correlations are falling and security-specific volatility is rising.

In general, the benefit from active management requires securities, relative to each other, and relative to the indices they comprise, to diverge in performance. Analysis suggests this is beginning to happen. In a world where expected returns for market risk are subdued, we believe active returns should be more explicitly emphasized as a driver of capital growth and income generation for investors. From an overall risk budget perspective, we see market risk crowding out active risk as the leading factor explaining returns.

Possible Actions to Help Address Active Risk

Allocate a greater share of capital to various types of active risk approaches that focus on absolute return generation from across both traditional and alternative asset classes.

MI_market_subdued_chart

Connecting the Dots: From Investment Strategy Implications to Product Strategies

We offer a range of strategies that we believe can help clients meet investment challenges while simultaneously addressing more than one uncompensated risk. This chart summarizes some of the strategies that may act as a possible resolution to the five prominent uncompensated risk challenges we have outlined. For more information about these Dreyfus strategies, view our funds.

MI_market_subdued_chart

Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund carefully before investing. Contact your financial advisor or visit Dreyfus.com to obtain a prospectus, or summary prospectus, if available, that contains this and other information about the fund, and read it carefully before investing.

Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. Real estate investment trusts are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Sovereign securities, including U.S. Treasury Inflation Protected Securities (TIPS) are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Management risk is the risk that the investment techniques and risk analyses applied will not produce the desired results and that certain policies or developments may affect the investment techniques available to managing certain strategies. The use of derivatives involves risks different from, or possibly greater than, the risks associated with investing directly in the underlying assets. Derivatives can be highly volatile, illiquid, and difficult to value and there is the risk that changes in the value of a derivative held by the portfolio will not correlate with the underlying instruments or the portfolio’s other investments.

An absolute return strategy is an unconstrained investment approach and performance is measured against a goal that reflects portfolio construction focused on risk management and is designed to deliver positive returns in changing market environments. Traditional “relative return” funds are managed to and measured against broad-based benchmark indices, rather than against “absolute” measures of principal risk.

The Standard & Poor’s 500, often abbreviated as the S&P 500, or just “the S&P”, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ. NASDAQ was created by the National Association of Securities Dealers (NASD) to enable investors to trade securities on a computerized, speedy and transparent system, and commenced operations on February 8, 1971. The Russell 2000 index is an index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.  VIX: CBOE Volatility Index (VIX) reflects a market estimate of future volatility for the S&P 500 index based on a weighted average of the implied volatilities for a wide range of option strikes. Shiller’s CAPE: Cyclically Adjusted Price-Earnings ratio (CAPE) based on the S&P 500 inflation-adjusted price divided by average earnings from the previous 10 years. Global Aggregate Index: The Bloomberg Barclays Global Aggregate Index provides a broad-based measure of the global investment-grade fixed income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate Indices. The index also includes Eurodollar and Euro-Yen corporate bonds, Canadian government, agency and corporate securities, and USD investment grade 144A securities.

Mellon Capital Management Corporation (“Mellon Capital”) is an investment adviser registered with the Securities and Exchange Commission (“SEC”) under the Investment Advisers Act of 1940. Mellon Capital is a wholly-owned indirect subsidiary of BNY Mellon. Standish Mellon Asset Management Company LLC (Standish) is a wholly-owned and independently operated investment management subsidiary of The Bank of New York Mellon Corporation (BNY Mellon).

“Newton” and/or the “Newton Investment Management” brand refers to the following group of affiliated companies: Newton Investment Management Limited, Newton Investment Management (North America) Limited (NIMNA Ltd) and Newton Investment Management (North America) LLC (NIMNA LLC). NIMNA LLC personnel are supervised persons of NIMNA Ltd and NIMNA LLC does not provide investment advice, all of which is conducted by NIMNA Ltd. NIMNA LLC and NIMNA Ltd are the only Newton companies to offer services in the U.S. Newton is a wholly owned subsidiary of the Bank of New York Mellon Corporation.

Investment advisory services in North America are provided through four different investment advisers registered with the Securities and Exchange Commission (SEC), using the brand Insight Investment: Cutwater Asset Management Corp. (CAMC), Cutwater Investor Services Corp. (CISC), Insight North America LLC (INA) and Pareto Investment Management Limited (PIML). The North American investment advisers are associated with other global investment managers that also (individually and collectively) use the corporate brand Insight Investment and may be referred to as “Insight” or “Insight Investment”. CISC and CAMC are owned by BNY Mellon and operated by Insight. The sub-adviser for the BNY Mellon Absolute Insight Multi-Strategy Fund is PIML, an affiliate of The Dreyfus Corporation.

Views expressed are those of the advisor stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. The Dreyfus Corporation, Alcentra, Insight, Mellon Capital Management, Newton, Standish, TBCAM, Walter Scott, and MBSC Securities Corporation are subsidiaries of BNY Mellon. ©2017 MBSC Securities Corporation, Distributor, 225 Liberty Street, 19th Fl., New York, NY 10281.

MARK-2017-03-22-1321 Exp. 12/2017