When it comes to choosing which asset class to buy in today’s market environment, the quandary investors face has been well-documented.
Many equity markets are trading on historically high multiples. In fact, over the last year alone, the worst-performing of the major indices in sterling terms is the FTSE 100, which is still up 23.91 per cent over 12 months.
Performance of indices over 1yr
Source: FE Analytics
Meanwhile, government bonds and global credit are trading on high valuations relative to history, despite a recent rise in yields caused by inflationary expectations.
Given this challenging backdrop, not to mention the geopolitical and macroeconomic uncertainty on the horizon, how are multi-asset managers positioning their portfolios to deliver investors the best risk-adjusted returns possible?
In the below article, five managers give their thoughts on the biggest risks today’s investors will have to navigate and which asset classes are offering up the best opportunities.
Hartwig Kos: “The market underestimates the potential of Le Pen gaining power”
Kos, who heads up SYZ Asset Management’s OYSTER Multi-Asset Diversified fund, says the biggest theme investors need to watch out for right now is politics.
For instance, he believes the election of Donald Trump as president has caused unfounded optimism in the US equity market – given his fiscal policies have not yet been implemented – and that there are a series of political hurdles in Europe for investors to overcome.
“In terms of how we are approaching things now, we are quite cautious,” he said. “We fear that the market underestimates the potential of [French presidential candidate] Le Pen actually gaining power so we have been positioning ourselves reasonably defensively, with low allocation to duration and relatively little allocation to equities.”
While the manager says a victory for Marine Le Pen winning the French election in May is not the “base case scenario”, he warns that the ‘leave’ majority vote in the EU referendum and the election of Trump as president proves that no outcome should be discounted.
Given this backdrop, Kos is holding very short-duration sovereign bonds as well as a 25.9 per cent cash weighting. However, he believes emerging market government bonds – such as Polish and Mexican bonds – look attractive on a valuation basis.
While 28.5 per cent of the fund is in both developed and developing market equities, he says he has minimised risk through the use of call options on volatility.
“We have been battening down the hatches on the portfolio and have been risk controlling the portfolio quite meaningfully,” he added.
Will McIntosh-Whyte: “It all feels a little like the calm before the storm”
While stock market volatility has been muted so far this year, McIntosh-Whyte, assistant fund manager of the Rathbone Multi-Asset Portfolio funds, warns that this could be short-lived.
“It all feels a little like the calm before the storm. The sharp end of European elections is quickly approaching; Brexit negotiations are primed to start, and the new US administration is preparing to unveil its new tax policy and (maybe) a boost to infrastructure spend,” he pointed out. “We believe politics will be the greatest driver of volatility this year.”
On the other hand, the manager says GDP growth is improving, company earnings are rising and oil prices have stabilised at a fairly low level, which is good for consumers and businesses while remaining profitable for the energy industry.
“We are happy to invest and so retain a material position in equities. When picking equities, we look for companies with pricing power and low debt levels in structurally growing markets,” he said.
“We have increased cash to prepare for higher volatility. This was raised mostly from longer-term bonds through the summer last year (we prefer shorter-dated investment grade debt) and more recently increasingly expensive alternative asset classes such as property.
“We would argue many popular alternative asset classes, especially real assets, carry as much interest rate risk as gilts, but without the guaranteed liquidity!”
McIntosh-Whyte is also using Commodity Trading Adviser (CTA) funds as they are less correlated to equities, and has counter-balanced their higher volatility levels with exposure to long/short equity funds.
Mike Pinggera: “We have a pretty challenging environment on the inflation and rates front”
Pinggera, who manages the Sanlam FOUR Multi Strategy fund, says the lack of clarity surrounding the election of Trump, ongoing Brexit negotiations and the upcoming European elections has been exacerbated by uncertainty relating to interest rates.
As such, he says now is a particularly challenging backdrop for multi-asset investors.
“Against this backdrop, FTSE volatility is currently trading at a 10-year low which seems a bit odd to me. In terms of volatility, we’re going back to 2007,” the manager pointed out.
“We’re in an environment where we have an expectation of inflation, with government bonds you have to go out longer than eight years to earn more than 1 per cent. It just seems to me that we have a pretty challenging environment on the inflation and rates front.
“Looking at the FTSE, we’re at a high. You have rising inflation, low rates and stock markets at historically high levels. That doesn’t make for the most productive environment to find attractive opportunities for the most part.”
However, given low levels of volatility and high amounts of market uncertainty, Pinggera says the use of options is the best way to utilise this backdrop.
His average bond duration is a little over one year and, since the fund’s launch in 2013, he has gradually been increasing his exposure to real assets from 10 per cent to 25 per cent.
While two-thirds of the fund’s underlying assets are directly linked to inflation, he diversifies this through the use of long-term themes that are pillars of a functioning economy.
For instance, he has exposure to real assets that are directly correlated with transport, education, healthcare and housing.
Anthony Rayner: “There is still a lot of noise out there from sterling”
Rayner, who co-manages the Miton Defensive Multi Asset, Cautious Multi Asset and Cautious Monthly Income portfolios alongside David Jane, is more optimistic on the current economic backdrop for the most part.
However, he believes it is a different story when it comes to the UK and, as such, has no direct exposure to the UK economy.
He said: “The US is flying and generally the economic data has been very strong. The eurozone is the same, the latest PMI numbers were very strong. Economies like China for example are bumbling along quite nicely as well.
“The UK is a slightly different case. It has been more resilient than people thought after Brexit, but there is still a lot of noise out there from sterling, from the uncertainty with consumers and the big decisions they’re having to make – whether it’s purchase decisions or investment decisions.”
While the funds have had no exposure to the UK economy over the last six months, a majority of Rayner’s equity exposure is in developed markets. He also has a fairly short average duration in terms of both his government bond and credit exposure.
As with Pinggera, he is also playing long-term themes in his portfolio that diversify away from the economy, such as new energy and cyber-security. However, he holds very little in the way of alternatives.
“You have equities, you have interest rates and you have credit. They’re the three things that are relevant across any asset or sub-asset class. Alternatives are made up of those as well, they’re just marketed a different way,” he argued.
Shrenick Shah: “Relationships between assets may change”
Shah, portfolio manager in the multi-asset solutions team at JP Morgan Asset Management, says markets have experienced an unstable and unconventional macroeconomic environment over the last four-to-five years.
“There’s been modest growth and quite large amounts of monetary policy but asset relationships and correlations have been relatively stable,” he said. “Now, we’re entering into a different phase and as we transition into the next one, relationships between assets may change.
“In such an unstable correlation environment, where correlations may or may not change, our multi-asset team relies less on diversification properties built on correlations from the past one-year period as they may not hold.”
Given we are in a period of change, Shah is focusing more on alpha and return potential as opposed to diversification, given that it could become scarcer.
“If correlations change, there’s less diversification available, so you need to look harder for stable diversifying correlations,” he explained. “For example, we believe the correlation between more growth-oriented cyclical equities and quality stable-return equities will remain low and allocating to these two sub-sets can help diversify the portfolio. But you don’t want to rely on stocks and bonds.”