Multi-assetJul 8 2014

Fund Selector: End of correlated returns

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

If you haven’t made money in the first half of the year, perhaps you should be wondering why, given that nearly all asset classes have produced a positive return since the beginning of January.

The list includes developed and emerging market equities, government and corporate bonds, commodities and commercial property. This is very unusual; the previous time we witnessed such market conditions was way back in 2003.

One of the biggest surprises so far this year has been the strength of the bond markets. Gilts, Treasuries, bunds et al had few friends in 2013 but all have produced solid returns during the first six months, as have investment-grade and high-yield bonds.

One possible explanation for this is the fact that inflation has been falling in many parts of the world. But there has also been more talk of interest rate hikes, particularly in the UK, although clearly someone forgot to tell the gilt market.

Global equities have also enjoyed a solid first half of the year with only Japan, out of the developed markets, failing to join the party. Emerging markets endured a torrid start to 2014, although returns have improved significantly since the end of January on the back of more encouraging economic and political news.

Meanwhile, we have seen a significant shift from mid- and small-cap stocks into large caps and no more so than in the UK where the FTSE 100 index has outperformed the FTSE Small Cap index (excluding investment trusts) by roughly 2 per cent in the first half, having lagged by more than 6 per cent at the end of January.

Away from the markets, the big talking point was the radical change to the pension rules announced in the March Budget.

This, of course, will be good news for those asset managers that have credible natural income offerings. However, we believe the main reason investors will allocate far more to income-producing assets has much more to do with changing demographics than changing legislation.

Looking ahead, we would be surprised to see such a high correlation of returns among differing asset classes continuing into the second half of the year.

Within our multi-asset income portfolios, we remain underweight bonds and equities and overweight UK commercial property. Within bond markets, we believe the best returns will be found in asset-backed securities, while we also maintain a reasonable allocation to floating-rate debt.

As far as equities are concerned, we have a bias to large caps within our portfolios with our favoured market being Japan. This position naturally raises a few eyebrows, although a number of factors point to a much better future for the Japanese stockmarket, including superior earnings growth and cheaper valuations, as well as signs of the long-awaited return of the domestic institutional Japanese investor.

Our decision to significantly increase our UK commercial property exposure in the past 12 months has certainly paid off and we remain constructive for the remainder of this year and beyond. This is especially the case for higher-yielding secondary property outside London, where spreads remain exceptionally wide compared with their historic norm.

David Hambidge is director of multi-asset funds at Premier Asset Management