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Where NOT to invest in 2019

07 January 2019

Several investment commentators highlight the areas of the market they will be steering clear of this year.

By Rob Langston,

News editor, FE Trustnet

Absolute return funds, UK gilts and European equities are among the assets that a panel of industry experts are most bearish about after a difficult end to 2018 and signs of further challenges on the horizon.

A year of benign market conditions in 2017 and global synchronised growth gave way to higher levels of volatility last year and the US economy diverging from the rest of the world.

Additionally, concerns over the Federal Reserve’s approach to raising interest rates, the burgeoning US-China trade war, Brexit and several other challenges have impacted investor sentiment.

Indeed, the developed markets-focused MSCI World index finished the year down by 3.04 per cent – in sterling terms – after a late sell-off for the S&P 500 index, which ended the year up by just 0.96 per cent.

Elsewhere, the MSCI Emerging Markets index was down by 9.27 per cent last year.

Performance of indices in 2018

 

Source: FE Analytics

But for UK investors with portfolios tied to the fortunes of the domestic market there was little cheer, as the FTSE All Share – which captures 98 per cent of the UK market capitalisation – fell by 9.47 per cent.

Things were slightly better on the fixed income side as the Bloomberg Barclays Global Aggregate index rose by 4.94 per cent during 2018, in sterling terms.

Yet, the headwinds that contributed to a more difficult end to the year are likely to continue making asset allocation decisions extremely difficult for investors in 2019.

As such, FE Trustnet asked several market commentators where they believe the biggest dangers for investors lie for the year ahead and which areas are likely to deliver the lowest returns.

George Lagarias, chief economist at wealth manager Mazars, said the firm does not try to avoid asset classes or regions out of conviction, instead trying to construct “very well balanced” portfolios.

However, there has been one allocation decision that the strategist has made more recently.

“We have recently significantly reduced our weight in absolute return funds, to the point of having just nominal exposure,” he said. “The reason behind that move was the idea that in the mature part of the cycle, correlations begin to depart from historical averages.

“This could have significant negative impact on multi-strategy [Standard Life Investments Global Absolute Return Strategies] GARS-like vehicles, which control risk through statistical processes.”



Lagarias added: “The move played out for us in the past few months, as with only a few assets rising, many of these strategies suffered.”

While popular with advisers and institutional investors in recent years, the IA Targeted Absolute Return sector has fallen out of favour more recently. Indeed, the sector was the worst selling in October 2018 – the latest data available – with net outflows of £864m, although it remains the third-largest by assets under management.

Mazars’ Lagarias said that, given the “exceptional lack of visibility” in markets, he does not hold a strong conviction on any particular area of the market and investors should also keep close to the benchmark.

“Currently, we are most bearish on British risk assets, as most Brexit scenarios lead to a moderate or sharp economic slowdown relative to the rest of the world,” he said, adding that it will review that position as the situation changes.

Brexit also weighs heavily on Adrian Lowcock’s mind, as the head of personal investing at Willis Owen urged investors to give UK gilts a swerve.

“This market is sensitive to interest rate rises which have largely been put off due to Brexit negotiations,” he explained.

“A positive outcome could mean more interest rate rises whilst a negative outcome is likely to weigh on the UK market for some time and might result in higher borrowing costs for the British government also pushing rates up.”

“Looking into 2019, we have very little exposure to longer-duration assets due to the ongoing interest rate increases in the US,” added GDIM investment manager Tom Sparke.

“This has been our position for some time and although assets such as longer-dated gilts have been useful in the recent more volatile periods we still see the path as negative for these and do not want to be holding them significantly.”

Performance of index in 2018

 
Source: FE Analytics

The departure of the UK from the EU could also have a negative impact on European equities, which already face their own challenges.

Indeed, European equities have had a torrid time in 2018, weighed down by the fallout from the US-China trade dispute and a budget spat between Italy and EU authorities.

As the above chart shows, the MSCI Europe ex UK index fell by 9.87 per cent in sterling terms during 2018.


 

“Europe remains a concern for us, the economy is slowing down and whilst much of the focus in the UK has been on Brexit, there are plenty of other political issues weighing on the region,” said Lowcock.

“The asset class is however trading on a discount to its long-term historic value but not significantly so. With stimulus coming to an end it is unclear whether growth will recover or not.”

Indeed, the European equity space is an area that GDIM’s Sparke has also been reducing exposure to more recently.

“The growth figures for the European area look like they may be weaker than anticipated,” said Sparke. “Political and budgetary issues such as those in Italy won’t help to steady these holdings when times are tougher and as we enter further electoral cycles in the region even more uncertainty could arise.”

Another area that Willis Owen’s Lowcock is avoiding is the high-yield bond sector, which could face greater challenges as the end of the current economic cycle nears.

Performance of index in 2018

 

Source: FE Analytics

“They are more vulnerable to the later stages of the economic cycle as interest rates rise and borrowing gets more expensive companies could find themselves struggling to service their debt,” he explained. “Add in the fact you are not being well compensated for by taking the extra risk.”

However, while investors might be better-off cutting exposure to the areas above, they need to think about reinvesting into other areas rather than sitting on piles of cash.

As, Mazars’ chief economist Lagarias noted cash is unlikely continue to provide investors with much in terms of absolute returns.

He reasoned: “Interest rates are set to remain shallow for years to come, which means real returns on cash will continue to be negative.”

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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.