This month's question: Have the recent market falls prompted you to change asset allocations?
Yes
Tom Sparke, investment manager at GDIM
The falls in stock markets during the third quarter were by no means unprecedented and showed some trademarks of typical late-cycle volatility. The market’s moves highlighted sensitivity in numerous areas including European equities, smaller companies and more cyclical sectors, such as technology.
With economic fundamentals in good shape and earnings still solid in most regions, the general path for equities should be toward appreciation, a position that is familiar to us as we have been set up for this over the past few years. Until recently, our relatively robust equity positions have experienced a low level of volatility and provided generous returns too. Assuming continued positive earnings translate to higher markets, we would expect this to be accompanied by significantly increased volatility as signs of weakness creep in and investors become more fretful of an impending slowdown and recession. We therefore believe that limiting some more of the downside in equities will smooth out returns and allow us to achieve a similar level of return but not have to chase further upside to make up for excess losses.
A gradual move to lower beta equity assets and to those with more resilient balance sheets, together with good earnings prospects, seems a prudent option in this environment. Utilising some more of our favoured diversifying assets, including property, infrastructure and secured bonds, will decrease market participation and sensitivity further and should garner similar results in terms of overall return but on a smoother path.
No
James Calder, research director at City Asset Management
The short answer to this question is no, although there have been a few days when I have wished otherwise. However, putting the economic or market backdrop into context, the latter stage of an economic cycle can be volatile.
As asset allocators seeking a real return for our clients, we are constantly challenging our views, especially as they have not changed for a considerable period – again a characteristic of the latter stage of an economic cycle. So why have we not changed our view? This is entirely down to a very benign economic backdrop: low unemployment (for most regions), an increase in wage inflation, core inflation being under control and loose monetary policy (US rates are still low by historic standards and are close to peaking), which are all strong positives.
This benign environment should be reflected through similar markets, although at the latter stage of the cycle markets can easily be spooked, and they are being spooked. This recent volatility can be firmly placed at the feet of politicians.
Asset allocation is a difficult job at the best of times, but second-guessing the outlook for trade wars, populist governments and Brexit is a mug’s game. The risk is increasingly being felt on the downside and concerns over a stock market recession are growing. As we manage multi-asset real return portfolios, by their very nature they have a high degree of structural defensiveness. The question that will vex us for 2019 is how much more defensive do we become and when and how we do it?
