Investment Week - Asset Allocation
01 July 2010
Earlier this year we advocated an active approach to investment rather than a passive strategy of buying markets, which we felt was unlikely to reward investors. This translated to discriminating between stocks within sectors and between countries within regions on the grounds that recovery and progress would be piecemeal. Halfway through 2010 that advice still holds as it is difficult to get a clear steer on where we are headed when looking at financial markets in general. The various asset classes are signalling very different outcomes.
Government bond markets are focused on signs of deceleration in the world economy, although deflation rather than ‘double dip’ appears to be the concern. Safety trades have featured in many markets, for example, trading out of peripheral Euro-zone government bonds into the ‘safer’ core or selling Euros to buy Swiss francs.
A more lasting after effect of the global financial crisis and recession is that global accords are in short supply, whether in relation to trade, economic workouts, regulatory reform, or the environment. What we are seeing instead is an increase in bilateral agreements on trade, and a loose consensus on the need for fiscal austerity in the developed world, amidst a range of views on how and when to introduce measures to achieve it.
As we head into high summer, traditionally a time of low volumes and hence potentially exaggerated swings in markets, risk aversion remains high and trading volumes have been low in most asset classes. Against this backdrop, it is sensible for the asset allocator to pay attention to the behavioural influences on markets, both as an aid to understanding the drivers of markets and identifying likely winning positions and, just as importantly, to avoid some of the traps posed by noise in the markets. For a more rewarding approach that is easy to advocate, but admittedly harder to implement, it may pay to extend one’s investment time horizons. The main advantages are twofold: firstly, many asset allocation and valuation tools are only effective over longer time horizons and secondly reduced trading costs, which obviously detract from performance.
Despite the dismal performance of most equity indices, corporate cash flow generation is healthy, which is just as well as bank lending remains mired in anticipation of increased regulatory capital requirements. Company balance sheets are also generally in good shape allowing investors to identify opportunities in both equity and corporate bond markets. There are obvious risks from market dislocations but encouraging signs that some markets are regaining a semblance of normality, for example new issues and mergers and acquisitions. As there are no obvious unequivocally attractive asset classes, asset allocations will tend to look neutral with selectivity underneath the indices remaining the key to performance.
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Bull points
- Strong recovery in corporate profits should feed through to improved dividend prospects.
- Markets are progressing slowly towards normality.
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Bear points
- Regulatory reforms are coming home to roost and political risk looms large.
- The macroeconomic environment is less supportive.
Frances Hudson, Global Thematic Strategist, Standard Life Investments
First published in Investment Week on 12th July 2010
