Four investment views that might be in your portfolio, and why you probably shouldn’t take them all

March 19, 2015 Categories: Investment Strategy, Markets

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It’s still a central banker’s world in 2015, but much of the chatter is, on balance, fairly upbeat.

The US looks to be at the start of a reasonably robust recovery, and the UK doesn’t seem far behind. Most commentators are optimistic that QE in Europe will deliver the required shot in the arm, and falls in energy prices will help the all important consumer get back to spending. Of course there are many risks and uncertainties – no one is (or should be) complacent. But nonetheless many investors are positioning for recovery. Here are some investment views that might be in your portfolio:

1: Short duration

You expect: Rising interest rates
You Predict: Fixed income that is less sensitive to rising interest rates such short-dated credit, loans, and high yield will hold its value better.
You risk: Higher credit risk, as this portfolio will typically be lower credit quality than all-duration investment grade credit.

2: Overweight risk assets generally

You expect: Economic recovery
You Predict: Risk assets will perform well as the global economy starts growing again
You risk: Risk assets are, well, risky

3: Overweight real assets

You expect: Rising inflation, driven by healthy demand
You Predict: Higher inflation feeds directly through to higher prices and yields in real assets such as property, infrastructure and commodities
You risk: Prices of real assets actually fall: many have been bought for their relatively higher yield compared to bonds in recent years, but as this gaps narrows and even goes into reverse investor may choose to switch back to bonds for yield.

4: Growth bias in equities

You expect: Rising equity earnings, driven by economic recovery
You Predict: Growth stocks, small cap and emerging markets most likely to benefit from global economic recovery
You risk: Equity valuations have already priced in a lot of growth, raising the bar for where earnings have to come in in order not to be a disappointment

Each of those can look pretty sound on a stand-alone basis. The question is: what if you have all these views in your portfolio at the same time? To what extent is your whole portfolio taking just one big bet on a global economic recovery, and are you comfortable with that overall level of risk?

Like any investment decision, choosing how to position your total portfolio for economic recovery is a matter of trade-offs. A total portfolio approach means you look at what happens in each part of your portfolio if the economic recovery gathers pace, and then decide where the best opportunity to profit from that exists. So perhaps it you’re going to juice up your credit portfolio with lots of shorter-duration but punchier credit, perhaps you should tone down a growth or small cap bias in equity portfolio. If you’re allocating up to real assets, perhaps you should balance that with other high-yielding assets that might benefit from outflows from real assets. And if you’re overweighting risks assets generally, perhaps you should include some skill-based strategies that are less sensitive to the economic cycle such as volatility-based strategies.

I think multi-asset portfolio management is like cooking: you need good ingredients, but it’s the delicate combination of them that makes a good dish great. Dishes need flavour (risk), but in the right and complementary quantity. Too many strong flavours can ruin the meal.

David Vickers – Senior Portfolio Manager

David Vickers

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