AFI Balanced: Bonds, cash likely to dominate at next rebalancing

Mini-rallies are expected in the recessionary environment we are in, but are likely to do little to break out of the current downtrend and the most discouraging is that the “green shoots” theory (of a potential early recovery) has been blown out of the water.

The AFI Balanced index continued its decline inline with this sentiment – although one should note it has been at less pronounced levels than equity indices as a result of the index’ multi-asset composition. This make-up allows for safeguarding against steep equity falls and results in the index being less volatile.

Further to these traits balanced managed portfolios have traditionally been in place to grow investors’ capital in a responsible manner over the long-term – thus pose a good defensive option during a recessionary phase. This approach avails a high inclusion of fixed income and cash, and the latest AFI rebalancing clearly reflected this flexibility with the index experiencing its highest ever exposure to these two asset classes – which now make up 33 per cent (a third) of the entire index. It is worth noting that this inclusion has been at the expense of UK equities which saw their lowest ever weighting of around 28 per cent of the index.

When glancing at balanced managed funds within the AFI Balanced index only three emerge – Neptune Balanced, Ruffer European and Miton Special Situation. Each of these funds have outperformed over the year posting -19.6 per cent, -3.6 per cent and 3.7 per cent respectively against the AFI Balanced index’ -20.1 per cent and the IMA Balanced Sector average return of -20.6 per cent over the same period.

If one were to probe more specifically into the holdings of these funds it’s evident that the better performing Miton and Ruffer funds have held relatively higher inclusions of cash and fixed interest securities – around 50 per cent levels – whilst Neptune Balanced has kept a more active near 40 per cent weight in UK equities.

However, in light of this high equity exposure, Neptune Balanced is more likely to prosper in a recovery situation and according to data from Financial Express has attracted the highest net retail inflows of any fund in the IMA Balanced Managed sector over the last year. Investors should note that the fund is managed by Robin Geffen, CIO and founder of Neptune, who promotes investment into his own funds so as to ensure that his interests are aligned with those of his investors.

In terms of geographical exposure within the index there may be a wider shift to US and UK securities at the next rebalancing given that both regions are pursuing the most rigorous stimulatory policies with a strong focus on quantitative easing – an approach that should see an earlier recovery for these economies. Both regions have seen interbank and base rates fall to historic lows – which are likely to persist throughout 2009 – therefore funds such as Martin Currie North America should remain popular across the AFI indices.

It is clear in terms of what to expect at the May 2009 AFI rebalancing – the currently defensive composition of the AFI indices are unlikely to change given that equity markets remain unclear – meaning bonds and cash are likely to continue their dominance over equities and illiquid assets, such as property. Cash and sovereign bonds should thus feature heavily despite being expensive relative to equities at present.

Commodity focused vehicles prospered over the last quarter and seem the only viable adjustment that may appear at the next rebalancing, with it more likely to see more advisors opting for BlackRock’s Gold & General or JP Morgan’s Natural Resources fund which are focused on extracting returns from commodity surges. Funds invested in commodities may prosper not only on rises in prices, but also due to the fact that these securities are priced in US dollars which many expect to continue to strengthen against other world currencies.

Macro-economic fundamental factors will also play an increasingly important role in allocation decisions given the recessionary stage of the business cycle we are in and as stimulatory policies start to impact financial markets in the second half of this year. Falling GDP and trade export forecasts are likely to keep leading indicators in negative territory – the most important of which is consumer confidence – meaning it is hard to see light at the end of the tunnel for now, which will no doubt be reflected through continued defensive positioning at the next rebalancing.

However, history has taught us that when an up-turn arrives it is likely to be sharp, thus there are merits for those advisors still attempting to predict the bottom of the market – as they would prosper more so than those sitting on the sidelines should a recovery take place – timing although remains the most important factor to such an approach.

We are certainly in an environment for the contrarian investor looking to pick up good value at cheap prices. However, despite valuations favouring such investors by pointing towards a good long-term buying opportunity, markets are still falling and if experience has taught us anything over the past year, the best strategy may be to wait and see where momentum takes us – especially since further downward revisions of future corporate earnings are underway and that on a historical basis the average recession lasts two years – meaning that if we are just in an average recession we still have a fair way to go before equities should warrant worthwhile interest.

Nevertheless the multi-asset approach the AFI Balanced index takes undoubtedly makes it a worthwhile consideration in an uncertain market.