Our Investment Committee meets on a quarterly basis to consider market conditions and the relative values of asset classes. Its views – looked at in more detail below – are then used to guide the strategies that are applied to each of our clients by their expert advisers, in accordance with their unique circumstances.
This has been a strange year for investment markets. The political shift in 2016 signals a move away from free trade and long-term economic growth – yet thus far markets have sailed through fairly calmly.
Is this because political events are not, in practice, going to affect economies? Perhaps so, but it is hard not to expect some contraction in the growth in world trade over the next 10 years which will ultimately be bad for markets. Countering this is continued economic stimulation which is boosting markets short-term, but may kindle greater long-term pain.
If you would like to discuss any of this, please do not hesitate to contact me or any of the Acuvest team.
Economic performance and outlook
As we pause at the end of 2016, we see huge change over the last couple of years. In 2015, we seemed to be mired in a situation where central bank stimulation was needed to keep up any sort of economic growth. Each cycle of attempts to remove the stimulation produced economic weakness. Through this, we saw lower and lower interest rates, weaker commodity prices and surprisingly strong equity markets.
The political changes in 2016 – Brexit, Trump etc – are good for neither globalisation nor long-term growth. But they seem to have coincided with a better economic outlook and some signs that we may finally be breaking out of the need for central bank stimulation. It is paradoxical that, only as we emerge from the problems of the 2008 crisis, there comes a major revolt against some of its causes.
We now see two factors pointing to the possibility of a substantial market shift: Trump’s proposed infrastructure splurge, and the fact that monetary stimulation looks likely to be replaced by fiscal, notably in the US but probably elsewhere too.
Interest rates are already rising, particularly in the US. The current presumption is that this will continue through 2017/18, at a slow pace. Given the above, we wonder if this is too sanguine. There must be at least a possibility of more rapid inflation and a sharper rise in interest rates in order to curtail overly rapid expansion. If this is so, it cannot be good for equity markets, given that there will no longer be such a search for yield. Add in potential contractions in world trade and we expect that there will be some market setbacks over the next couple of years which should provide more attractive investment opportunities across all asset classes.
Higher inflation and interest rates would likely have some spin-off in Europe, with the prospect of a revolt by France, Spain and Italy against EU fiscal rules. The rise in populist voting in all developed countries will surely drive a reduction in short-term austerity.
Bond performance over past year
Source: Merrill Lynch, Irish Governments 10+ yrs, German Governments 10+ yrs, EMU All Non-Sovereigns 10+yrs, US Governments 10+yrs, 21/12/2015 – 19/12/2016, total return, locally priced
2016 has seen bond yields fall to all-time lows before rising sharply again. German 10-year bonds went negative for the first time this year but are now back to around 0.3%. US yields are again over 2.5%. There has been little change in the spread of German yields over peripheral, with the exception of Italy where the banking sector is struggling.
Yields do remain low overall: where bonds are being used for matching and it is possible to take some risk, it seems sensible to either shorten duration or move into alternative investments.
Commodity performance over past year against equities
Source: Thomson Reuters Core Commodity CRB Index, MSCI ACWI equity index, priced in US dollars, total returns, 21/12/2015 – 19/12/2016
Commodities are dominated by energy with the oil market having been extraordinarily volatile through 2016. This month has seen Opec and non-Opec countries strike their first deal to cut production in over 15 years, sending crude oil prices sharply higher.
We do not believe that we are in a major upcycle in commodity prices. Opportunities arise from time to time however when particular markets become depressed; in relative value terms, non-energy commodities may offer some short-term protection.
Hedge fund performance over past year against equities
Source: Credit Suisse Broad Hedge Fund Index (priced monthly), MSCI ACWI equity index, priced in US dollars, total returns, 21/12/2015 – 19/12/2016
Hedge funds as a group have posted poor returns over the past year. Although market volatility is significantly lower than that for equities – due in part to lower liquidity – fees remain high and performance has been below par relative to equities for some time now.
Equity performance over past year
Source: MSCI standard core data, 21/12/2015 – 19/12/2016, local pricing
Markets generally have approached their highs after falls of 10 to 20 per cent in early 2016. Currency movements have advantaged the euro investor over his dollar-based counterpart. In these circumstances, hedging has become far more important and we have been recommending that clients – who have benefitted from being unhedged – should consider changing their stance at this time.
Valuations again look stretched and we currently recommend clients maintain an underweight position.
Property values have been reasonably stable (apart from in post-referendum UK), with relatively high yields offsetting reduced economic confidence. We continue to believe that property exposure is sensible, and are recommending clients who are below target weight in property to move up to target.
We see the eurozone as the home market for Irish clients, rather than the more concentrated, more volatile, and often less liquid Irish market.
Sharp movements in currencies in recent months have given some opportunities for gains (and losses). Avoiding the Swiss franc recoupling was a necessity. These funds continue to be a useful diversifier.
Global tactical asset allocation funds
These funds provide good diversification benefits because of their broader investment universe.
These are floating rate sub-investment grade instruments with a strong covenant and a term of between six and nine years. The premium return over cash rewards illiquidity and credit risks. The class offers another diversification.
Short-term interest rates remain low and sit either negative or barely positive everywhere in the eurozone. The ECB is under no pressure to increase rates. We continue to advise clients to include yield-enhancing alternatives to cash in their portfolios when this can be done at an acceptable risk.
Portfolio structure and risk management
- It is very important that clients have a disciplined management framework for determining how to structure portfolios and how to adjust that dynamically over time.
- Acuvest recommends that portfolios comprise a diversified mix of asset types which balances the desire for high returns with management of the associated risks. For this purpose, we group assets into three categories: growth (including equities and property), managed risk (including global tactical asset allocation funds and certain types of hedge funds) and defensive (including bonds and cash).
- Within clients’ portfolios, we currently advocate an overweight position in GTAA funds, high yield bonds, commodities and property. Balancing this, we are underweight equities.
- In a low-return environment, keeping fees low is particularly important.
- In building a portfolio, getting exposure to the equity risk premium efficiently is key. Given its low cost and avoidance of manager risk, passive investing should be considered as a baseline against which to assess the best way to gain exposure. Acuvest does, however, recommend using active managers where we believe they can add value, for example by exploiting their skill or where markets are less efficient.We have changed our position on currency hedging over the past year because of the depreciation of up to 20 per cent in the euro versus the dollar. While some movement was to be expected, this is excessive and looks artificially high. On balance, we recommend euro investors to be at least partially hedged at these levels.