Interesting times? The industry’s favourite euphemism of the past six weeks needs to be retired. For investment professionals, this should be an unabashedly exciting time, the moment when their decisions and actions on behalf of clients will have the greatest impact.
Sticking to the old strategic asset allocation might not be good enough in a world that seems set for profound change. That is, however, one of a number of potential strategies that MICHAEL BAILEY, GREG BRIGHT, SIMON MUMME and STEPHEN SHORE discuss with investment decision-makers over the following pages.
Some of the strategies that follow can be used in combination, others hearken back to a less complex time and could be used in splendid isolation, many will think that some should not be used at all. They are hardly meant as a coherent plan.
Yet at a time where most CIOs seem to be standing still – one complained to us that there was “too much dust in the air” – these debates might just inspire the first steps toward recovery of clients’ money.
1. Take a deep breath and BUY EQUITIES .Rebalance to your strategic allocation and have faith that the recovery will happen eventually.
Not for the first time, the most memorable reaction to this proposal came from John Coombe, executive director at JANA Investment Advisors. “Buy, buy, buy. How many times can you write buy?” he asks Investment & Technology when we speak. “It doesn’t matter which markets anymore, or whether you back one particular style, because all managers are seeing great value.” Coombe says the decision to dive into equities will obviously depend on your outlook for earnings and economic growth; “but even if you’re pessimistic, it’s still good long-term buying”.
For the JANA veteran, the tipping point was during the first two weeks of October. “[Equities] were reasonable value before then, but now they’re cheap.” However Tim Unger, senior investment consultant at Watson Wyatt, cautions against plunging back into equities simply because risk premia have widened and valuations appear cheap. Unger says he is wrestling with what advice to give to institutional clients due for a portfolio rebalance.
“We have not recommended that clients who periodically rebalance their portfolios should now stop, but I think what were once considered reasonable levels of earnings in the finance and banking sector are unlikely to be repeated. “Rebalancing is a legitimate investment technique, but it is based on a set of expectations, and if there has been a regime shift, if the game has changed, the assumptions that underlie rebalancing may no longer apply. Perhaps now is not the best time to top up equities.”
“There is always a danger in saying ‘this time it is different’, because 99 times out of 100 it turns out not to be different,” he says. “But then there is that one time that it is. Unfortunately, like most things, it is usually not clear until well after the event. “If it is different, then you don’t have history to help you. The nature of advice you can give has to be more qualitative in nature. There are conditions in the 1920s and 30s where you could draw parallels to today, but it is never perfect.”
Unger says the extent to which other industries are going to be affected is not obvious, and it is not clear where the value is. “So far, what we have seen has been largely a financial markets response. We are yet to see the flow-on effects for the economy.”
Taking an opposing view is Geoff Warren, director of capital market research at Russell, who says he couldn’t disagree more with funds not maintaining their equities allocation. “In fact, I think this is exactly the sort of time you should be rebalancing your portfolio,” Warren says.
“Markets have become uncertain about the future, and there are a lot of risks out there. So markets have repriced in a way that you end up with low returns for safe assets, meanwhile the risk premium is now very high for accepting the uncertainty that comes with risky assets.” Warren doubts that those investors still stockpiling cash have a strong justification for taking that view.
“Their answer will be something like: ‘there is uncertainty and the world has changed’, but we don’t really know that. I think you should go back to your default position when you lack strong evidence that your default position is wrong. “On top of that, I would argue that if you were going to vary from your default position, the returns on risk have gone up and you should hold more risk exposure rather than less. If anything I would be overweight equities.”
The Russell researcher says that if one was to build a bearish argument for equities from here, one would have to believe in some sort of permanent downshift in corporate profitability. “The market tends to front run the economy, and it has been pricing for a disaster. I do expect there to be a downturn in profits, but that is now priced into the market, and the question you have got to ask yourself is: ‘is there a scenario out there now that could be worse than the market is anticipating?’ That is possible, but the more it goes down the more remote that possibility becomes.”
Not only should investors be trimming their underweights to equities, they should rethink what had become conventional wisdom in terms of geographic and sector allocation, according to Trevor Greetham, asset allocation director at Fidelity International. He believes the global economy will soon enter a “reflation” phase.
“Within equities, I think we could be seeing the start of some important new trends. I’ve moved US equities overweight at the expense of Asia and the emerging markets. I continue to move money away from industrials, including resources, covering an underweight in global financials held since April 2007, increasing my overweight in healthcare and moving slightly overweight the global consumer sector,” he says. “Financials and consumer stocks are historically the best performers in the reflation stage of the cycle and they’ve been underperforming the broader equity markets for a long time.”
2. Do nothing, at least as long as cash is yielding 8 per cent or so.
AustralianSuper has been the most celebrated advocate of this strategy to date. It’s investment committee has hoarded almost all of the $3 billion it received in the year to October in cash, while at schemes like AGEST and Seafarers Retirement Fund, the members have been rushing into ‘readies’ all by themselves. “It’s a brave fund which is not building up cash at this stage,” says Funds SA chief executive, Richard Smith.
“We need to be sure that the global banking system can be recapitalised… one plank of that is the rescue packages being accepted by markets.” Of course, even if you’re “doing nothing” it’s not a good idea to actually do nothing, especially since the risk/ return dynamics of the cash asset class were turned on their head last month by the Rudd Government guarantee on all bank and credit union deposits.
Australian fixed income broker FIIG Securities says investors should switch into guaranteed deposits or guaranteed debt instruments with the highest yield, irrespective of the issuer, as the Government’s decision to guarantee bank deposits means all issuers under the guarantee are essentially Australian Government AAA risk. FIIG Securities head of research, Justin McCarthy, calls the guarantee an “unprecedented opportunity” but warns investors to ensure their term deposit maturities occur within the three year time frame of the Government’s offer.
“The announcement by the Government means a complete change in the fixed income competitive landscape. Unusually, deposits with authorised deposit-taking institutions are now less risky than semi-government bonds. We expect State Governments to lobby the Federal Government for inclusion to remove this distortion. However under the current conditions, on a relative basis, term deposits or bank-issued guaranteed bonds offer a higher yield with a Federal Government guarantee,” McCarthy says.
The news only gets better for those stockpiling cash. McCarthy pointed out that not all short term investments were covered, and that excluded providers like foreign banks and cash management trusts would have to offer even higher rates to attract depositors. National Australia Bank obviously thinks the guarantee will lure more wholesale investors into cash. It has traditionally borrowed from institutions (NCDs), but as these instruments are not covered by the guarantee, the bank recently established its first-ever institutional term deposit facility.
It’s a lure best avoided, thinks Australian Unity chief investment officer David Bryant, one of many who believes those currently overweight cash will live to regret it. “Not sticking to your long term asset allocation can bring irreparable harm to your returns. Nobody can pick the bottom. If you’ve been stockpiling cash and are trying to get back in during a volatile market, chances are that you’ll make the decision on the 4 per cent up day but have it implemented on the 5 per cent down day. This is no time to be diverging from your long-term strategy,” he says.
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