Fundselector: What’s on the menu for 2012?

The question is, will the new year diet of positive economic news and rising markets continue to be served up over the rest of the year, or will it be replaced by a menu of uncertainty, lower growth, defaults and disappointments?

On balance, we are inclined to believe that the positive start to the year may prove to be a false dawn and that there will be more disappointments than successes in 2012.

Optimism may prevail for some time as investors are encouraged by improving economic data from the US, alongside easing concerns over Greece and better banking liquidity in Europe.

However, in spite of what the markets are telling us, the economic backdrop remains broadly unchanged and the outlook is highly uncertain. Europe is likely to remain weak as it falls back into recession under the weight of debt that has been accumulated over many years of excess.

This will dampen growth more generally, particularly in the UK, where we expect the economy to stumble along between weak growth and mild recession as austerity bites.

Meanwhile, Asia and emerging markets are at the mercy of a soft landing and the controlled deflating of the property bubble in China. At the same time, government bond yields, in spite of being underpinned by a supportive interest rate outlook, offer little value.

On balance then, when we step back and look at the market’s upward trajectory, we feel that it is more likely to run out of steam than pick up pace. It would appear to have run ahead of reality.

So how should investors react to this outlook? In our view, it is important to be selective in terms of the choice of assets, while at the same time maintaining broad diversification. Equities should continue to be held as they are supported by compelling valuations, good corporate profitability and healthy balance sheets. More specifically, tilting portfolios towards defensive investment styles such as quality or yield proved to be a successful strategy last year and we would argue that such positioning remains compelling today.

In fixed income, exposure to investment grade corporate issues offers a compelling risk-adjusted return relative to government bonds where yields are at record lows and therefore have limited further upside.

In the area of alternatives, absolute return strategies should be sought. These have become more abundant and varied since the introduction of the EU’s Ucits III funds directive and are attractive on the basis that consistent and uncorrelated returns will be at a premium in this environment.

Finally, alongside selectivity and diversity in terms of choosing sources of outperformance, we would add opportunism to the range of skills that successful investors will require in 2012. We expect there to be a significant level of volatility this year and those who can identify mispricings in a timely manner are likely to be rewarded.