As investors prepare to navigate rising inflation, low rates, high valuations and continued risks from Covid-19 over the coming months, a robust approach to generating returns is needed.   

At Goodbody, we believe portfolio construction is a critical balance of risk and reward as well as client objectives and constraints. It is therefore important to ensure that portfolio construction is measured precisely to an investor’s risk profile.

To do this, we must first get the balance of equity and safe assets (usually high-quality bonds) right, even if that sacrifices some potential return. The second most important thing is to ensure diversification within the asset classes, avoiding too much concentration in any one theme or sector.  We use the model portfolios prepared by the investment team to do this, but very often an investor has a constraint or preference that means we need to adapt and so, we have to keep these principles in mind.

How to prepare for rising interest rates

For portfolio construction, the possibility of rising rates poses a difficult question because rising rates tend to hurt all asset classes in some way. So, it can be a challenge to diversify this risk.

One of the main things we do at the moment is to keep our fixed income exposure biased to shorter maturity bonds.  These are much less sensitive to rising interest rates in the short run and over time will even benefit from reinvestment at higher yields. 

We also have a bias to corporate credit risk, as economic growth stays strong.  So, default rates should stay low. Within equities, investors should have a diversified exposure across sectors – and ideally, they should not concentrate in sectors where valuations may be over-extended and interest rate rises may hurt the most.  Healthcare is one such example where concentration may be preferred as valuations in that sector are not challenging. 

Navigating volatility and market uncertainty

In the last two years, financial markets have experienced periods of tumult owing to the coronavirus pandemic – and with the emergence of the Omicron variant late last year, it is important to build a portfolio that can withstand and travel through today’s uncertain environment – and that is measured precisely to an investor’s risk profile.

What’s more, investors should have a clear long-term plan that is driven by realistic expected returns and an assumption that the unexpected can and very likely will happen along that journey. 

If you build the right plan, then it will be robust to such shocks and you will not be forced to change direction at just the worst possible time – so, as we look towards the unknowns of 2022 and beyond, have a clear plan that is suited to your risk profile and experience, and stick with it. 

Read more about our investment outlook for 2022-2026 here.