In the third episode of Allspring’s 2023 outlook series, Brian Jacobsen, senior investment strategist, and Matthias Scheiber, head of Systematic Edge Multi-Asset for Allspring Global Investments, discuss the five dimensions to purposefully refining portfolio construction after a year when traditional balanced portfolios got battered.


Matthias Scheiber: Multi-asset liquidity management, we believe, can potentially bridge the trade-off between the safety of the principal and achieving attractive results.

Brian Jacobsen: That’s Matthias Scheiber, head of Systematic Edge Multi-Asset for Allspring. I’m Brian Jacobsen, senior investment strategist for Allspring Systematic Edge Multi-Asset, and you’re listening to On the Trading Desk®. After a year when traditional balanced portfolios got battered, investors may be trying to figure out how to refine their strategies. We’re going to suggest that purposeful refinement may be the way to go. What is purposeful refinement? Matthias is going to help describe the five dimensions to purposefully refining portfolio construction. Thanks for joining me, Matthias.

Matthias: Thank you, Brian, for having me. And thank you for the nice introduction. Glad to be here.

Brian: Yes, it was an unusual year for investors. Looking back, did anything work in 2022?

Matthias: Yeah, that’s a tricky question to start with Brian. There are a lot of things that didn’t work, which probably come later into this podcast. But yes, the short answer is yes, there were a couple of strategies that worked. One was downside risk management from 2019 through 2022. There were actually two significant equity drawdowns for very different reasons. One in 2020, that was demand driven, and the latest one was inflation supply driven with also very different drawdown profiles. But these events confirmed our previous research that no single protection strategy works all the time and that the combination of carefully assembled strategies may work better. And that actually worked in both environments for us. The second one, I would like to mention is the alternative risk premia approach. It also did very well. You can think of these factor strategies like value, carry and momentum across assets, so in equities, in bonds, in commodity, and effects. And they’re market neutral, so long-short, so they prove their value this year, as well, as people continued and investors started to focus on fundamentals again.

Brian: Now, in our 2023 Outlook, we have a description of a five-dimensional approach for positioning multi-asset strategies. So, let’s briefly hit on each one of those dimensions, and then how they relate to positioning for 2023. So, let’s start with the first dimension. Maybe the biggest one is macroeconomics.

Matthias: Thank you, Brian. And you mentioned absolutely important framework. So, let’s start with macroeconomics. Indeed, it was messy. A messy, macroeconomic mosaic. The macro story of 2022 was, obviously, mostly about inflation. This has caused some fundamental challenges to multi-asset investors, as, for example, traditional concepts like diversification were seriously challenged. In 2023, the macroeconomic picture might not improve, so that’s the bad news. The good news is that at least markets have had an opportunity to adjust in the pricing to that uncertainty of a rather somber growth and inflation outlook. So, rates, for example, may have already reset, if not overshot to the upside. Considering the equity market drawdown we had in 2022, we’re actually also constructive on the outlook for the broader equity market. 2022 was a year in which people were challenged on traditional diversification, as I mentioned, but 2023 could be a year where traditional diversification makes a comeback.

Brian: Yeah, I really hope that 2023 is maybe the comeback tour year for traditional diversification. So, after macroeconomics, the next dimension is factors. And factors are the features of assets that make a difference for building portfolios. How can we get our factors fit for 2023?

Matthias: Indeed. You’re mentioning an absolutely crucial point. And obviously, a lot of those factors got challenged over the past 15 years because of central bank influence. And central bank influence caused higher correlations, but also lower volatilities across assets. And the central bank’s expanded the balance sheet, they bought not only government bonds, but in some instances, they also bought corporate bonds and some even equities, so they were rewarding strategies like momentum, more than traditional strategies like valuation or value strategies. In 2022, though, we saw strategies like carry of value where significant factors again can play the role in asset returns. The market obviously worries about waning growth and persistently high inflation. And that obviously triggered a return to fundamentals, which we believe, long-term, is good. It prompted investors to refocus on valuation and carry in the second half of last year. We believe investors’ preference for strong fundamentals at reasonable prices is unlikely to fade quickly. Diversifying across factors could potentially make a portfolio more resilient than simply diversifying across traditional assets similar to what we have seen last year. Considering the disappointment performance of traditional assets in 2022, however, a sharp recovery in 2023 can’t be ruled out in both equities and bonds. Inflation is decreasing growth, as well. That should initially help the bonds because they benefit from both while equities need to fully reflect it in their earnings but should long term also benefit from it.

Brian: Yeah, after disappointing, or after diversification-disappointed, hopefully, we can see a little bit more delight from diversification again in 2023. So, let’s turn now to the third dimension, which is more about idiosyncratic opportunities. Can you describe what that means and your thoughts for 2023?

Matthias: Yes, obviously, last year was a challenge, as we said, for traditional assets, but every challenge also represents an opportunity. And we actually see an environment of abundant idiosyncratic opportunities. So macro uncertainty has caused economic divergence and different speeds of central bank rate adjustments. The U.S., for example, was the most aggressive in hiking as was part of emerging markets. While Europe was lagging, Japan and China were further easing monetary policy. So, a lot of divergence. There are two specific areas we believe may offer tactical opportunities in 2023. The first is currency related. Over the past 10 years, half of emerging markets’ underperformance relative to U.S. equities can be actually explained by currency moves as the dollar strengthened. We think this may change going forward with currency moves instead becoming neutral to additive to emerging market performance. The second potential opportunity we see for 2023 is adding duration back into portfolios. We think the Fed’s (Federal Reserve) rate hikes will likely end, inflation rates will likely fall, and that growth is highly uncertain. To us, this combination seems like a favorable environment for long-term bonds. However, technicalities can change quickly. The reaction function of central banks might be more cautious than what the market is pricing. A higher terminal rate or rates higher for longer cannot be ruled out. So, higher volatility in rates is likely to persist. And this calls for a more tactical, opportunistic approach during this year.

Brian: Yeah, I think that really ties in nicely to the fourth dimension of constructing a multi-asset portfolio, which is really that downside protection, about what happens if things go wrong. So, can you talk about downside protection and its role in 2023?

Matthias: Yeah, Brian, you’re spot on, as usual. When inflation risk is the market’s dominant risk, stocks and bonds can sell off together, as we saw in the first three quarters of 2022. Our research has shown that the correlation between equities and bonds tends to increase when the inflation uncertainty, not necessarily the level, is high. Those nowhere-to-hide markets call for patience and downside risk management or a bit of both. But nowhere-to-hide markets can give rise to everyone-wins markets where stocks and bonds both do well once inflation risk subsides. Structurally, higher volatility is likely back and it favors downside protection strategies. In our view, diversification is not that despite its near heart attack in 2022. However, adding more explicit protection strategies on top of diversification makes a lot of sense to us.

Brian: Well, and then that brings us to the fifth and final dimension, which is liquidity management. I always view this as a way of if you have kind of your cash flows mapped out and you don’t have to be a forced seller into markets, that can make you an opportunistic buyer. So, can you talk about the importance of that fifth dimension, liquidity management, as we navigate our way through 2023?

Matthias: Yes, definitely. And you are mentioning a huge investor focus, especially in the second half of last year. Prudent liquidity management is at the heart of our risk management. Keeping always enough liquidity not to be a forced seller during volatile market periods is essential. When liquidity was abundant, investors tended to seek higher returns and more diversification, partly through illiquid assets. But there can be too much of a good thing, though. We believe some investors, and we have seen it, partly lightly overallocated to illiquid assets, which by their nature are difficult to sell. So, it’s hard to meet liquidity needs on margin calls in other parts of the investor portfolio with an illiquid asset. Our view is that cash and short-duration fixed income strategies have value beyond just their yields. Their value includes their meeting to spending needs and the peace of mind that comes with having the flexibility to be patient in the midst of market volatility. Obviously, long-term, this would mean sacrificing returns that are more attractive. Here is where multi-asset can help. Multi-asset liquidity management, we believe, can potentially breach the tradeoff between the safety of the principal and achieving the attractive returns by addressing both strategic goals and short-term liquidity needs at the same time.

Brian: Well, thank you for that, Matthias. It’s really important for investors to learn from the past while avoiding investing for the past. Investing is about the future. And so, thank you for giving us that perspective.

Matthias: You’re welcome, Brian, and thanks for having me on. It was a great pleasure talking to you.

Brian: Until next time, I’m Brian Jacobsen. Stay informed.

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Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses.

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