Pensions Week - Hot asset classes for cautious investors
17 May 2010
We are living in interesting times, which is not necessarily good news for cautious investors. A cyclical recovery in the global economy is underway, albeit on a piecemeal basis. After last year’s gains across most asset classes, markets have been volatile and have made little headway at an index level but dispersion within markets has increased, providing alpha rather than beta potential.
Traditional safe havens and secure sources of income, such as government bonds, are subject to very different economic recovery trajectories, and are being tested by fiscal stress, politics and consequent threats to sovereign ratings. For the asset allocation decision, there are relative calls to be made as interest rates are raised in some places and remain on hold in others. Unconventional support measures such as quantitative easing (QE) are being withdrawn in some markets but not others and we have even seen the start of central bank bond buying in the Euro-zone. The potential issuance needed to fund fiscal deficits adds yet more complexity to the analysis. There are concerns about fiscal sustainability to varying degrees in parts of the Euro area, the UK, the US, and Japan. Low policy rates makes holding cash less attractive and encourages investors to look for sustainable sources of yield from other sources, such as corporate bonds, commercial property or equity income.
So, if cash is unattractive and government bonds carry the burden of debt shifted from the private sector to the public what of the other asset classes? Corporate bonds and property do offer prospects of better yields, but on a selective basis as higher returns are resuming their traditional relationship, being associated with higher risks.
As far as equities are concerned, earnings have taken over from broad macro themes as the main driver. In general earnings growth is strong but investors are also looking at revenue growth and confidence about future prospects, an environment which favours a bottom-up investment style. Some of the emerging and commodity markets, once dismissed as too risky and exotic, start looking more attractive and relatively stable. The natural structural shift from the developed to the emerging economies has been accelerated by the financial-sector problems and recession that have had greater impact in the debt-oriented and deficit-running economies of the developed world. US, UK and Japanese stock markets, which comprised 73% of equity market capitalisation seven years ago, accounted for just 59% by the turn of the year. For cautious investors, direct investment in emerging market stocks may still be a step too far but it is perfectly feasible to gain exposure via blue-chip global companies listed in the developed markets.
At the start of 2010 the advice was to diversify, discriminate and look for sustainable yield and that advice still holds for cautious investors. Rather than taking a broad brush approach and investing at index level, longer-term fundamental analysis is required. One of the driving forces of recent years, globalisation, seems to be on hold if not in full retreat. Analysts who looked at global sectors and stock specific factors again have to consider country risk but not just in equity markets. At the same time, countries are not immune to the ills of their neighbours and this impacts currency. Contagion between some of the peripheral Euro-zone economies has taken its toll on the euro, emphasising the importance of considering currency exposure in investment decisions.
Frances Hudson, Global Thematic Strategist – Global Strategy, Standard Life Investments
This article was first published in Pensions Week on 31st May 2010
