Market outlook and investment focus areas for 2023 

The global economy is caught in a number of secular and cyclical cross-currents that have the potential to move markets dramatically.

Firstly, inflation remains a significant concern for the global economy. While there are signs that inflation may have peaked in some markets in the near-term (notably in the US), headline inflation remains high in most countries and it is unclear how long it will take for inflation to move down towards central bank targets. More worryingly, there are secular factors at play, which include de-globalization and the energy transition, that suggest an increased risk of higher inflation over a longer-term.

Given that most central banks in the developed world are continuing to raise rates to combat inflation, we expect global economic growth to remain soft in the year ahead. This could create headwinds for the performance of risk assets. And if inflation continues to surprise on the upside, we could end up with challenging conditions for equities and fixed income assets.

On the other hand, valuations are now more attractive given the substantial correction in asset prices over the past year. Market sentiment is also depressed, hence, markets could experience relief rallies on potential positive news such as central banks slowing down the pace of rate hikes or the Chinese government re-opening its borders.

Investors should continually review their portfolios to ensure that they are well balanced and appropriately resilient under varied economic conditions. Given the current climate, we think institutional investors should be focused on the following:

• Sufficient allocations to assets such as private equity, infrastructure, natural resource stocks and inflation-linked bonds can improve the portfolio’s ability to overcome the challenges of achieving a desired real rate of return in an inflationary environment.

• Absolute return-oriented strategies such as those pursued by many hedge funds tend to have low correlations to equities and bonds, and can enhance portfolio diversification. The past year has demonstrated that simple equity-bond portfolios are ill-prepared for situations where inflation is a key risk concern. Hence, with potential economic weakness on the horizon and against a backdrop of persistent inflation, we believe that hedge funds will be a valuable addition to most institutional portfolios. However, this is more than simply an asset allocation decision, as “hedge funds” is a broad term that encompasses a range of strategies with a variety of risk and performance characteristics. Thorough manager due diligence and deliberate portfolio construction are critical to avoiding disappointment and achieving the desired outcomes from investing in hedge funds.

• Flexible capital strategies such as credit opportunities funds can be a provider of liquidity in stressed or dislocated situations. They are well-positioned to capitalize on opportunities that emerge in a period of economic uncertainty, when banks and other traditional sources of liquidity have a reduced appetite for risk taking.

Investors today have at their disposal a wide range of sophisticated strategies to construct portfolios. To navigate the challenging environment ahead successfully, investors will need to draw upon the arsenal of investment options available to them, and not count on what has worked over the past decade to continue working in the future.