Home / Economics / Continued volatility opens door to skilful investment: Franklin Templeton

Tightening of central policy on a global scale is creating valuation arbitrage across the board, and creating opportunities for skilful investors.

The shift to tightening economic persuasion amongst central banks in 2022 is creating a swathe of investment opportunities for managers that have the skill and will to take advantage of them, according to US investment group Franklin Templeton.

In its September ‘Global Investment Outlook’ paper, Actively selecting opportunity in uncertain times, the money manager says a violent swing from near-zero to rapidly rising interest rates across the world has caused serious ructions across the entire investment spectrum. “Unsurprisingly, when central banks tighten aggressively, price volatility tends to rise across all asset classes,” the paper notes. “Already underway, that process is likely to endure.”

Tighter economic conditions create an increase in economic and earnings risk, the manager explains, noting that US federal reserve chief Jerome Powell indicated “pain” was unavoidable. Because the outlook on central bank policy is so unclear (after a concerted period or ‘lower for longer’ stability), fixed income and equity markets will continue to move.

“In fixed income markets, volatility jumps because inflation- fighting central bankers can no longer confidently guide investors about their future policies,” Franklin Templeton notes. “Data dependency replaces forward guidance and given the uncertain linkages between supply and demand fundamentals driving today’s inflation, no central banker can confidently communicate where interest rates will be in three, six or 12 months. Accordingly, short-term interest rates and bond yields are likely to gyrate more significantly than was the case when central banks were targeting zero interest rates.”

The fundamental shift from quantitative easing (asset purchasing) to quantitative tightening (the reduction of asset purchases) is continuing to spook investors.

“Against the backdrop of huge increases in government and private sector indebtedness, the removal of central banks as bond buyers will likely continue to increase fixed income volatility,” the manager says.

According to Ed Perks, chief investment officer and portfolio manager at Franklin Income Investors (pictured), the gyrations caused by central bank tightening may be just dramatic across equity markets as they are in the fixed income sector.

“Most opportunities for income generation are in the fixed income space right now,” Perks says. “But we are mindful of attractive opportunities in equity sectors that have suffered steep price depreciation in recent drawdowns – such as financials and information technology.”

Another avenue of opportunity for investors arises through the difference in monetary policy across economies, as different central banks attack the economic malaise at different speeds.

“A growing divergence of monetary policy – some central banks are tightening aggressively (e.g., the Fed and the Bank of England), others more slowly (e.g., the European Central Bank) or not at all (the Bank of Japan) – will likely drive an interest-rate ‘wedge’ between domestic yields across countries, creating conditions for larger exchange-rate moves,” the paper notes. “The US dollar’s advance this year is the prime manifestation of how monetary policy divergence also creates greater exchange rate volatility.”

As this is happening, more “idiosyncratic” opportunities are being created, the manager continues. For investors, that means employing the skill of active managers to hunt those opportunities has become an attractive option.

“While it may seem like we are advocating for all sectors, asset classes and regions, the fundamental message is that the current conditions create a better environment for utilizing skill to achieve excess returns, both from active asset allocation and thoughtful investment selection.”