Summer Investment Monitor: Asset class grid

Steve Waddington, portfolio manager, multi-asset strategy group, Insight Investment

Equities

The cyclical momentum in global equities has slowed since the start of the second quarter amid a stabilisation in fundamental or ‘hard’ economic data. While the general global growth backdrop remains supportive, it could be argued that valuations are rich in some regions. We have maintained our cyclical bias and have directional exposure in areas where we find valuations more attractive. We also seek to capture specific idiosyncratic range-bound or breakout opportunities within total return strategies – which, in aggregate, aim to generate returns that are less dependent on market direction.

Bonds

We expect the negative correlation between government bonds and equities to persist in the medium term. This, together with a lack of inflationary pressures, suggests the space will retain an important role as a diversifying asset within portfolios. A normalisation in the volatility of the asset class has also helped. Similar to equities, developed market credit spreads have been supported by the general pick-up in cyclicality as expectations of improving corporate profits and falling default rates have influenced prices. We think emerging market debt remains vulnerable to US treasury yield volatility and US political uncertainty in the medium term but we believe the asset class provides some value opportunity.

Commodities

The recent gyrations in commodity prices have served as a reminder of the impact supply-side considerations can have on particular commodities. But cyclical forces should be a key determinant of the path of the broader commodity complex in the months ahead.

Property

Certain types of real assets can provide an alternative, diversifying exposure should inflationary risks build further. Infrastructure continues to be an area where we see opportunities. The outlook for long-duration infrastructure assets with predictable income streams and some inflation linkage remains attractive. Conversely, mainstream global-listed infrastructure indices tend to have a high economic sensitivity and a higher beta to global equities, which is less attractive and highlights the importance of targeting specific infrastructure exposures. Securities that have an operational bias and strong, long-term cashflows tend to have a lower beta to global equity markets, helping to further diversify a portfolio.

Alternatives

Our range of total return strategies aims to generate returns that are less dependent on market direction. Year to date we have seen some strong contributions from our range-bound and breakout strategies, which represent holdings where we expect relevant markets to trade within specified ranges, or break through their historic ranges. We see a continued difficult environment for currency opportunities in total return strategies. Volatility since the start of 2017 has led us to run lower-than-average risk in less directional strategies. For dividend strategies, we typically look to add during periods of market stress, but the constructive market environment means we have reduced exposure as valuations have become less attractive.

Meike Bliebenicht, senior product specialist, multi-asset, HSBC Global Asset Management

Equities

We have a moderate pro-risk bias in our multi-asset portfolios, and at broad asset class level we prefer equities over bonds. The macro economic backdrop has been improving substantially over the past 12 months and global economic growth momentum remains solid, feeding through to corporate earnings. For example, eurozone PMI rose to 56.8 in April, with manufacturing expanding at its fastest pace in six years. But headwinds exist from more modest Chinese growth, tighter US monetary policy and political uncertainty in many regions. Given that global equity markets have already performed well, current valuations seem less appealing than in previous years and may have less of a buffer to absorb disappointing news. 

Bonds

We believe prospective returns for global government bonds appear low, relative to competing asset classes. But in a multi-asset context, government bonds always have a particular role to play in portfolios with lower-risk profiles. The macroenvironment remains more supportive for investment-grade corporate bonds, and momentum is improving with implied recession probabilities appearing to be low. Corporate fundamentals are also improving for global high-yield bonds following a pick-up in the activity cycle. Defaults remain comparatively low, and we think they are likely to be contained to certain sectors. However, compressed high-yield spreads leave a thin margin of safety, which is why we have recently reduced our overweight in the space.

Commodities

US Federal Reserve rate hikes are likely to remain gradual, limiting the opportunity cost of holding non-yielding assets such as gold. Rising inflation could boost hedging demand for the precious metal, while high political risks/uncertainty could also be supportive. Oil demand growth remains robust, providing scope for the market to continue to rebalance, particularly following Opec’s November output cut deal. Of course, markets could remain oversupplied if US production remains resilient. Our view is that commodity futures, in aggregate, offer poor prospective returns and we currently do not include exposure to commodities in our multi-asset portfolios.

Property

Real estate equities are, in our view, priced to deliver reasonably attractive long-term returns compared with developed-market government bonds. In the long run, rents are positively related to economic growth and may also offer a partial inflation hedge. However, we believe that the market has focused too heavily on real estate equities as a bond proxy, and rising rates could have a negative impact in the short term.  

Alternatives

We currently do not have exposure to hedge funds or private equity in our multi-asset portfolios as we do not believe they provide the necessary diversification benefits to justify the higher cost of accessing the asset classes and their reduced liquidity. But infrastructure investments remain a valuable source of diversification for clients who require income from their portfolio, and we retain an allocation to this asset class within our multi-asset income portfolios.

Rory McPherson, head of strategy, Psigma Investment Management

Equities

Equities look fairly attractive at present based on positive earnings and easy(ish) policy. Valuations aren’t compelling, but this is heavily skewed by the US market – which is outright expensive. Regionally, places such as Japan and emerging markets offer decent value, and earnings growth in both these regions is very strong. Japan remains our key pick. 

Bonds

Core bond markets look very expensive, with yields at heavily depressed levels. We are happy to own these assets tactically but do not believe they offer long-term value. Within fixed income, we favour European asset-backed income securities that benefit from decent yields, good flows and very low sensitivity to interest rates. High-yield markets have had a decent run, but still offer reasonable carry in a world of low yields.

Commodities

Commodities are beginning to look attractive based on oversold sentiment indicators. We like being contrarian, and given the recent negative price action they are currently flashing as being a good entry point. Valuations are not particularly compelling in pure-play commodities due to the upward sloping nature of futures curves. We would argue that commodity and resources stocks offer better value and would benefit from the resurgence of the reflation trade, which has been overly penalised recently. 

Property

We access property through global real estate investment trusts (Reits) as opposed to bricks-and-mortar property due to the illiquid nature of the latter. We currently have near-zero holdings in Reits across our portfolios. It is the sensitivity to bond yields that really turns us off holding these assets, as price movements have taken them into overbought territory. Many of these assets are US based, and the retail outlook there continues to worsen. 

Alternatives

Alternative investments cover a massive catch-all category of strategies. At present we favour those with low or negative correlation to equities, to provide protection should equity markets pull back from what look like toppy levels. Our alternatives allocation combines emerging market debt, long-short equities, credit and currencies, and macro-trading strategies to try to benefit from some of the distortions in investment markets.