However, it’s not just retail investors who are scratching their heads, as the experts are also finding it very difficult to build portfolios in the current market – as Tom Becket, chief investment officer at Psgima, explains.
“Trying to plot a course through financial markets at this point in time and trying to tell you what is going to happen next is probably as difficult as it has ever been in my career,” Becket (pictured) said.
Though Becket says making a definitive prediction on markets is nigh on impossible at the moment, in order to help out retail investors who are also confused, he highlights the six major themes which have dictated his asset allocation going into 2015 and the reasons behind them.
Sell last year’s top performers
Becket’s first major theme relates to his equity exposure, as he thinks the best course of action is to back more contrarian markets due to his belief that US equities will “tread water” over the coming years.
According to FE Analytics, the S&P 500 has strongly outperformed the other developed markets over the past 12 months.
Performance of indices over 1yr
Source: FE Analytics
However, while Becket is bullish on the US economy, he thinks its equity market will underperform from here as valuations are now very high and choking off the chances of decent long-term returns.
“We think that contrarian equities, be that some emerging markets, Europe or Japan, should outperform US equities,” he said. “That shouldn’t come as a huge sweeping statement, given the valuation discrepancies between an expensive US and a modestly priced end of the years.”
Japan is your best bet
The manager says investors should sell the US and turn to Japanese funds, which apart from a rally in 2013 due to the implementation of ‘Abenomics’ and huge stimulus measures from the Bank of Japan, have materially underperformed against other developed markets over recent years.
While Japan moved into recession last year and concerns have been raised about the effectiveness of prime minister Shinzo Abe’s “third arrow” of structural reform, Becket firmly believes positive steps are being taken within the economy.
He also points to the fact that the equity market is being flooded by central bank liquidity.
“We think Japan is still a very interesting investment opportunity,” Becket said.
“We continue to expect a positive outcome from Japanese equities and we think there is massive change taking place in Japan, which should fuel the next leg of the equity bull market. It is still our preferred equity region around the world.”
One highly rated fund which is geared into a recovery in Japan is FE Alpha Manager Chris Taylor’s Neptune Japan Opportunities fund, which sits on the FE Select 100.
Taylor took charge of the £500m fund in May 2005, over which time it has been the best performing portfolio in the IA Japan sector with returns of 181.06 per cent, nearly tripling the returns of its TOPIX benchmark in the process.
Performance of fund versus sector and index since May 2005
Source: FE Analytics
With the central bank ramping up its QE programme and as the yen is expected to weaken considerably, Taylor says the profitability of Japan’s leading businesses will finally be unlocked. He therefore told FE Trustnet that investors could make 10 times their money over the next five years.
A niche fund which will deliver strong returns
As FE Trustnet recently highlighted, Becket’s colleague, Tim Gregory, is very bullish on European equities as he says QE from the ECB is almost guaranteed now the OMT has been ruled legal by the courts and the eurozone has fallen into deflation.
However, while Becket has a significant weighting to European equities in his portfolios, he says there is another part of the continent’s market which is likely to have a barnstorming year.
“In terms of Europe, it’s not just equities, but we also expect areas such as ABS [asset backed securities] to deliver good positive returns this year.”
For his exposure to the European ABS market, Psigma use a segregated mandate managed by TwentyFour Asset Management, but retail investors can gain similar exposure via the five crown-rated TwentyFour Monument Bond fund, which has returned 23 per cent over three years and yields 2 per cent.
Though many investors will likely steer clear of the ABS market given its part in the global financial crisis, Becket is bullish on the asset class as the ECB, in plans drawn up last year, has already stated its intention to buy up the market as part of its stimulus measures.
Emerging market debt funds will bounce back
Funds within the IA Global Emerging Markets Bond sector have been hit with a multitude of headwinds over recent years, thanks largely to the US Federal Reserve’s plan to tighten monetary policy.
Currency weakness and concerns about current account deficits meant money flew out of the sector, but Becket says the selling has created a very good opportunity for investors.
“We think the sell-off we saw at the end of last year, particularly in emerging market debt, really offers a great opportunity to invest in high quality credits and in high quality emerging market governments at yields of around 8 per cent,” he said.
“We think that is an opportunity worth taking for patient medium-term investors.”
One of FE’s best rated funds in the sector is the £80m Aberdeen Emerging Markets Bond, which has five FE Crowns, a yield of more than 6 per cent and invests across both sovereign and corporate debt markets.
Performance of fund versus sector since Mar 2011
Source: FE Analytics
Though the fund has struggled recently, it is top quartile since its launch in March 2001 with returns of 18.13 per cent.
The reach for yield will continue
Linking to his previous theme, Becket says that as the chances of interest rate hikes in the US and UK this year are diminishing by the day, investors can expect assets which throw off a decent yield to perform well as people scramble to income.
He therefore expects equity income funds and high yield bond funds to deliver good returns to investors this year, especially as the recent volatility have caused yields to widen.
“I’ve purposely avoided telling you when interest rates are going to rise in the UK and US. Our view a few weeks ago was that rates would probably be raised in the autumn, but after the falls we have seen in commodity prices – particularly the oil price – we expect hikes to be pushed back until the beginning of 2016,” Becket said.
“In that environment, anything with a yield – be it high quality equities, high yield credit or ABS – should perform pretty well.”
Now is a good time to buy protection, especially gold
Becket admits that his final theme might seem a little strange, given recent news.
However, despite the fact the eurozone officially moved into deflation, UK inflation is down to just 0.5 per cent and the oil price keeps falling, Becket is looking to buy assets which offer future inflation protection now they are very cheap.
“Index-linked assets might make absolutely no sense in this point in time from an inflation outlook, but from a price and protection outlook, we think there are reasons to look back again at things like gold and other selected inflation-linked assets elsewhere,” he explained.
While certain experts disagree, gold is commonly viewed as one of the better hedges against inflation shocks. Though the gold price has been trending downwards over recent years, over the last few weeks or so it has spiked and is now up 10 per cent so far in 2015.
Performance of indices in 2015
Source: FE Analytics
An increased appetite for safe haven assets has been given as a major reason for the rally, which has left the gold price at $1,258.