Where the experts are taking risk, and holding back

With markets continuing to absorb geopolitical shocks, persistent inflation and uncertainty over interest rates, professional investors are becoming increasingly selective about where they are willing to take risk. While few are turning outright defensive, many are reassessing long-held assumptions around diversification, market leadership and the role of fixed income within portfolios.

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For some, that still means leaning into equities – particularly areas linked to structural growth themes. Others are looking beyond traditional asset allocation models altogether, with growing interest in alternatives and real assets as traditional equity-bond correlations break down.

Taking selective risk in equities

Despite a more uncertain macro backdrop, few investors are turning away from equities as a long-term growth engine. Instead, many are becoming more selective, focusing on areas where long-term structural growth drivers remain intact and valuations remain reasonable.

Darius McDermott, managing director of FundCalibre, sees “a compelling case for broad global equity exposure”, arguing that resilient earnings and increasing dispersion between sectors, regions and styles are creating a more favourable backdrop for active managers.

He is also constructive on emerging markets, citing attractive valuations and long-term trends including industrialisation, technology adoption, rising middle-class consumption and supply chain diversification away from China.

For exposure, he highlights WS Montanaro Global Select A GBP Acc for its focus on global small and mid-cap growth companies, as well as JPMorgan Emerging Markets Growth & Inc for its deep research bench.

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Others are finding opportunities more specifically within Asia. Samir Shah, senior research analyst at JM Finn, says the firm is overweight Asian equities, where growth is increasingly being driven by domestic demand and rising household incomes rather than external trade alone.

“This provides a more resilient foundation for earnings growth in a more uncertain global environment,” he says.

The wealth manager expresses this view through the Schroder Asian Total Return Inv. Company, which backs quality growth companies poised to benefit from rising consumption, technological innovation and improving corporate governance across Asia.

Treading carefully amid elevated valuations

While investors remain willing to take selective risk, many are increasingly wary of the narrow market leadership and elevated valuations underpinning recent equity market gains.

David Coombs, head of multi-asset investments at Rathbones Asset Management, is “becoming extremely cautious” on the “AI super trade”, particularly the sharp momentum-driven rally across semiconductor and memory-chip stocks. He warns that parts of the market are beginning to resemble a “melt up”, noting that the sector has historically been highly cyclical and volatile.

To manage positioning, Rathbones uses two ETFs – iShares MSCI Global Semicondctrs ETF$Acc GBP and Franklin FTSE Korea UCITS ETF GBP. “Using an ETF provides liquidity as this is a tactical trade and also reduces individual stock volatility, which has been extremely high,” he says.

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JM Finn is also seeking to mitigate broader equity market risk amid elevated valuations and market concentration.

“There’s a risk that higher long-term interest rates place pressure on valuations, particularly if earnings growth proves weaker than expected,” says Shah. “In such an environment, markets could be more vulnerable to periods of de-rating.”

The firm has recently introduced the Redwheel Global Intrinsic Val R GBP Acc fund, which is run by the same team as Temple Bar Ord. “We see the team’s ability to differentiate between genuinely mispriced opportunities and value traps as a key strength,” adds Shah.

Expressing thematic conviction

Despite concerns, technology and AI-linked investments continue to attract conviction, although investors are becoming more nuanced in how they access the theme.

Peel Hunt favours specialist technology strategies positioned to benefit from what Anthony Leatham, head of investment companies research, describes as the early stages of a much broader AI investment cycle.

That view is echoed by James Carthew, head of investment companies at QuotedData, who says: “The game is moving on from a narrow group of US mega-cap stocks to a much broader set of companies that are supplying components and power to support the data-centre capex boom.”

Both point to the “AI maximalist” thesis of Polar Capital Technology Ord, which has doubled investors’ money over the past year but still trades at a discount of around 8%.

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Healthcare is also emerging as a selective area of conviction. Peel Hunt highlights International Biotechnology Ord as a beneficiary of ongoing M&A activity in the biotech sector.

“In the six months to the end of February, five portfolio companies were subject to takeover bids, bringing the total number of IBT portfolio companies acquired since 2020 to 35,” says Leatham.

Coombs has been adding to medical technology stocks, where valuations have “de-rated dramatically” over the past 12 months despite what he sees as strong long-term fundamentals.

He points to Boston Scientific Corp, which has seen its valuation fall from around 40x earnings to closer to 15x, arguing that the sector is not an obvious victim of the AI disruption trade. Abbott Laboratories and Stryker Corp are also held within the Rathbone M-A Strategic Growth Port S Acc.

Being flexible in bonds

Allocators are increasingly cautious on fixed income amid concerns that inflation may prove more persistent than markets anticipate.

FundCalibre’s McDermott says ongoing geopolitical tensions and uncertainty around future rate cuts continue to create volatility across bond markets, making broad-based fixed income exposure less attractive.

“In this environment, I believe flexibility within fixed income is particularly important and would favour strategic bond funds where managers can actively adjust duration, credit exposure, regional positioning and overall risk levels as market conditions evolve,” he says.

He likes M&G Strategic Corporate Bond GBP A Acc, while Tom Bigley, fund analyst at interactive investor, favours Jupiter Strategic Bond I Acc.

Casterbridge Wealth is underweight fixed income relative to peers, favouring short-duration (bonds with low sensitivity to interest rate changes) and inflation-linked exposures while relying more heavily on alternative strategies for portfolio diversification.

Managing director Matthew Cheek highlights Aegon Absolute Return Bond GBP B Acc for its ability to run negative duration and actively short bonds, thereby “generating returns in precisely the rising yield environment that makes conventional fixed income so vulnerable”.

The firm’s traditional fixed-income allocations are anchored at the shorter end of the curve, through exposures to short-dated gilts and US treasuries, as well as the AXA Global Short Duration Bond Z Acc and Royal London Short Duration Global Index Linked funds.

Seeking sources of diversification

Investors are increasingly looking beyond traditional stock-and-bond portfolios altogether. Cheek says Casterbridge has spent considerable time discussing what it calls “The BIG Investment Breakdown” – the shift towards positive correlations between equities and bonds, undermining the traditional diversification benefits of the classic 60/40 portfolio (60% in shares/40% in bonds).

“We believe too many clients are heading into, or already in, a diversification trap,” he says. “We are moving away from the herd and looking at diversifying away from bonds into alternatives.”

Casterbridge has increased exposure to a range of alternative income and diversification strategies, including infrastructure, healthcare real estate, private credit and private equity, alongside absolute return strategies.

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Portfolio holdings include International Public Partnerships Ord, Welltower Inc, Sixth Street Specialty Lending Inc and HgCapital Trust Ord, as well as the MontLake DUNN WMA Inst UCITS GBP Retl P fund for systematic trend-following exposure and Jupiter Merlin Global Equity Absolute Return for its historic low correlation to global equities and bonds.

Bigley also sees opportunities within real assets after tensions in the Gulf and disruption around the Strait of Hormuz sent oil prices rocketing.

“Real assets offer a direct way to navigate this backdrop,” he says, arguing that commodities and infrastructure can provide more resilient income streams and inflation linkage in a volatile macro environment.

He highlights the WisdomTree Enhanced Cmdty ETF - USD Acc GBP and the FTF ClearBridge Global Infras Inc WAcc fund.

Rethinking infrastructure and renewable income

Despite their traditional role as income diversifiers, infrastructure and renewable energy trusts are facing growing caution.

Peel Hunt analyst Markus Jaffe warns that rising bond yields, shifting inflation expectations and government policy intervention have created additional uncertainty around portfolio valuations.

“The discounts are wide and the yields are attractive, but the movement in government bond yields presents a headwind to the sector re-rating in the near term,” he says, warning that “an optically high yield might reflect risks lurking beneath”.