It’s been a year of painful lessons, with high inflation, an aggressive monetary policy response and the war in Ukraine wreaking havoc on stocks, bonds, and other assets.

But ultimately, one year is a short time frame in investing.

Dan Lefkovitz, strategist at Morningstar Indexes says for many, the best course of action is to tune out and hang on.

"Investment performance in 2022 may end up as a small blip on a long upward sloping chart," Lefkovitz says.

"More important, perhaps, are the lessons that have been learned this year—about expecting the unexpected, preparing for the worst, and accepting how little certainty there is in investing."

Here are his five key learnings from 2022.

Lesson 1: Diversification isn't always a 'free lunch'


Diversification has long been referred to as "the only free lunch in investing," but Lefkovitz says classic stock/bond diversification simply has not worked in 2022.

The Morningstar US Moderate Target Allocation Index, which represents the traditional mix of 60% stocks and 40% bonds, declined nearly 13% through the first 11 months of 2022.

And declines across both equities and fixed income have weighed on Morningstar's range of multi-asset indexes for investors in Australia, Canada, the eurozone, Japan, New Zealand, and the UK.

"Fixed income is supposed to be a boring but stable asset class, capable of keeping a portfolio ship steady even in the stormiest waters," Lefkovitz says.

As for other forms of diversification in 2022, Lefkovitz says neither gold – a millennia-old store of value – nor cryptocurrency – a more modern inflation hedge – served that function.

"Some alternative strategies, such as trend-following, have finally done well after many years of languishing," Lefkovitz says.

Where do investors go from here?

Lefkovitz says the good news is that bond yields have risen in most major markets.

"Fixed income increasingly offers an alternative, which may not be great news for equities, but certainly gives debtholders and income investors much to celebrate," he says.

"Giving up on bonds does seem premature. Market behavior in 2022 has been unusual, but bonds may well return to their diversifying ways. If anything, we've learned that correlations can bounce around."

Lesson 2: Rising rates don't have a predictable impact on stocks


Value stocks have trounced growth stocks in 2022, with the Morningstar Global Value Target Market Exposure Index outperforming its growth counterpart by nearly 20 percentage points over the year to November.

But while rising interest rates are commonly blamed for the decline in growth stocks, Lefkovitz says research from investment management firm AQR disputes that link.

"Consider style performance in prior periods of rising rates. The [US] Federal Reserve hiked rates by 2.25 percentage points from 2015 to 2018, but growth stocks thrived," Lefkovitz says.

"Morningstar's global growth and global value indexes were both up big in those years.

"Then there was 1999, a year in which the Fed raised interest rates three times, but the dot-com bubble propelled growth stocks into the stratosphere."

Dividend-paying stocks also shone in 2022, despite views that rising rates can weigh on dividends.

"The lesson for investors? Don't try to time the macro environment," Lefkovitz says.

"Growth stocks, especially technology, entered 2022 carrying sky-high valuations, after years of market leadership. Energy and other dividend-rich areas on the value side of the market looked more attractive.

"For dividend investors, fundamental factors like quality and financial health are far more important than interest rates."

Lesson 3: Sustainable investments aren't immune to market cycles


In recent years, it’s been argued that strong environmental, social, and governance (ESG) practices have contributed to outperformance.

For the five years through 2021, 80% of Morningstar sustainable indexes with five-year histories outperformed their conventional equivalents, Lefkovitz says.

So, what's going on in 2022?

The Morningstar Sustainability Leaders Index – which excludes several classes of stock and selects companies with the lowest ESG-related risks – has lagged in 2022, as have many sustainable investments.

Analysis by Morningstar’s director of sustainability research, Jon Hale, says the story behind this can be partly explained by the growth bias of many sustainable equity funds.

"Many of these growth companies—internet, technology, consumer cyclicals—do relatively well on how they handle material environmental, social, and governance issues, so they tend to be overweight in many sustainable equity fund portfolios," Hale says.

What happens when the growth bias is removed from a sustainable portfolio? Lefkovitz says Morningstar’s Global Sustainability Large-Mid Value Index outperformed the market in 2022.

"The sustainability value index includes the shares of companies with value characteristics that also carry low levels of ESG risk," Lefkovitz says.

"Similarly, the Morningstar Global Markets Sustainability Dividend Yield Focus Index has outperformed by a wide margin. As discussed above, dividends have been a bright spot in 2022."

In general, Lefkovitz says any investment that deviates from the market portfolio will outperform in some market conditions and underperform in others.

"Just as the five years through 2021 undermined skeptics who dismiss sustainable investing as necessarily entailing a performance sacrifice, returns in 2022 have shown that "doing good" doesn't always lead to "doing well"."

Lesson 4: Growth themes don't always grow


From cybersecurity to connected cities to blockchain, investments that focused on themes tripled their market share over the decade through 2021, according to the Morningstar Global Thematic Funds Landscape Report.

But 2022 saw fortunes turn.

Consider the performance of the Morningstar Exponential Technologies Index, which includes 200 global stocks exposed to nine themes, including computing, healthcare innovation, and robotics.

"For the five years through the end of 2021, the index rose 171% in cumulative terms, versus a 97% advance for its global equities parent," Lefkovitz says.

But over the year to November 2022, the index has slumped more than 22%.

"Another thematic index, the Morningstar Global Digital Infrastructure & Connectivity Index is down even more, having declined 25% in 2022," Lefkovitz says.

He says some thematic indexes with less exposure to technology have performed better.

For example, the Morningstar Global Food Innovation Index fell just 8% over the year through November.

"The struggles of many thematic indexes in 2022 do not invalidate the themes in the long term or mean the wrong securities were selected," Lefkovitz says.

"Similar to the discussion of sustainable investments above, it points to the inevitability of performance cyclicality for any deviation from the market portfolio."

Lesson 5: Private markets don't only go up


Lefkovitz says the boom in private market investing in recent years can be measured by the performance of the Morningstar PitchBook Listed Private Equity Index, which includes the shares of public companies focused on private assets.

In the five years through 2021, the index rose more than twice as high its public counterpart.

"As in many of the stories discussed above, 2022 saw a reversal of fortunes," Lefkovitz says.

"The index fell twice as far as its parent. Even as private equity and venture capital funds continue to report strong performance, public markets sniff trouble ahead."

According to the Morningstar PitchBook Global Unicorn Index, Unicorn creation has also slowed. A 'Unicorn' is defined as a late-stage venture capital-backed global company with a valuation of at least $1 billion.

"Headwinds include rising interest rates, potential recession, and public market struggles," Lefkovitz says.

"But no matter the short-term outlook, structural factors mean private markets are likely to remain an important feature of the investment landscape.

"Raising funds in private markets is easier than ever thanks to more than $11 trillion in assets in private equity, venture capital, and other private-market vehicles."