Psigma Investment Management has moved to a more defensive strategy following “one of the most interesting and rewarding periods for investors in the last few decades”, expecting that further challenging times are on the horizon. 
While investors went into 2016 expecting a difficult time due to concerns such as low commodity prices, slowing economic growth in China and the UK’s referendum on its membership of the European Union, the year so far has been a pretty decent one for returns.
FE Analytics shows that the FTSE All Share has made a 14.26 per cent total return year to date while the Bloomberg Barclays Sterling Gilts index is up 11.68 per cent.
The fall in the value of the pound following the Brexit result has benefitted UK firms that export or import their earnings in dollars. Sterling investors have also reaped rewards from investments outside the UK because of currency, especially in the case of emerging markets.
Performance of indices in sterling over 2016
Source: FE Analytics
Tom Becket, chief investment officer at Psigma Investment Management, said: “The last few months has proved to be one of the most interesting and rewarding periods for investors in the last few decades.
“In all honesty, not many would have expected to have enjoyed such positive returns through the summer months, given the shockwaves initially unleashed by the UK electorate’s decision to leave the EU on 23 June and the threat of further political upheaval later this year, on both sides of the Atlantic.
“However, the twin expectation of lower for longer interest rates and a potential increase in infrastructure spending has trumped political concerns in the short term. At the same time, the pressure that each and every investor and saver is under to find returns has supported asset markets and driven many global indices up to cyclical and, in some cases, record highs.”
However, Becket’s best guess for the coming months and year is that the environment will be as “interesting” as the one that dominated 2016 albeit offering fewer easy opportunities to generate returns.
When it comes to global growth, Psigma’s expectation is that it will remain “dull not disastrous” and will resemble the recent past in many ways. Structural growth is expected to continue to be lower than that of the previous decade and means that corporate profits will have nowhere near as strong a tailwind, putting somewhat of a lid on future equity returns.
The UK’s vote to quit the EU adds uncertainty over the future health of the economy, as the country has already witnessed both positive and negative consequences of the decision. Although Psigma thinks it is still too early to make a sensible prediction on the UK economy over the long term, it expects to be looking less at UK equities and more at international ones over the coming years.
Looking at the world’s largest economy, Becket is “less optimistic on the outlook for the US economy than most”, being particularly worried that its recent growth is too reliant on the consumer while corporate investment is stuck at very weak levels.
“A big surprise for markets in 2017 could be that the US economy slows down even further than the insipid levels of growth experienced this year. We believe the Federal Reserve will try to raise interest rates in December 2016, but that this might be the last rate hike they can make for a while,” he said.
“A key impediment to growth is that the US political backdrop is both poisonous and unpredictable. A key message from our quarterly group investment committee was that politics poses the greatest threat to investors and the US election is central to that prognosis.”
Performance of indices over 3yrs
Source: FE Analytics
Furthermore, Psigma has become more cautious on Europe owing to the belief that its growth will remain disappointing until there is a better political backdrop and there is “decisive action” in the financial sector. Expecting movement on either of these issues in the near term is “wishful thinking”, according to Becket.
He is more positive on Japan, which has many of the same challenges as the European economy. However, he says that there are “plenty of exciting investment opportunities” in Japan, especially when it comes to corporate ‘self-help’ stories, and the country is expected to be a rewarding part of the portfolio.
Emerging markets are another area where Psigma remains optimistic, despite the challenges being seen in some parts of the asset class, and has sizable allocations to India and Indonesia following recent reforms. “Risks remain high, certainly, but so do opportunities, even after the stunning gains recently enjoyed by emerging market assets,” Becket said.
In light of the above issues, Psigma thinks the risks facing investors have increased at a time when valuations have become more expensive.
The group has taken profits from its equity positions and reduced both developed world and emerging market allocations to underweight. Although it is not expecting outright falls in stocks, Psigma adds that the risk of an equity market correction seems to have been underestimated and is preparing for more challenging conditions while building up a tactical reserve of cash.
“The overall risk levels in our portfolios have been reduced significantly since the start of the year. The volatile market conditions that we suffered at the end of last year afforded investors a ‘once in a cycle’ opportunity to make excellent returns, similar to what we last saw following the European debt crisis of 2011,” Becket said.
“Much has now changed, both in terms of the potential rewards on offer to investors and the shape of our portfolios. We have reduced some of our contrarian investments (such as lower rated corporate bonds, emerging market equities and resources investments), whilst overall equity risk has come down and we have added a greater emphasis towards defensive investments.
“After deliberately positioning for what we saw as a great time to be taking higher levels of risk at the start of the year, we would suggest that we have now become more balanced in our strategies.”
That said, Becket says Psigma’s portfolios have not been positioned with an “excessively cautious” stance, noting that it continues to strongly back themes of conviction such as Japanese equities, the Asian consumption theme, inflation protection and specialist fixed interest investments.
“However, we believe that core bond and equity markets might labour as we head into next year and we are finding value harder to come by,” he concluded.