After a volatile six months, risky assets may rebound in the coming weeks, following the European Central Bank’s generous lifeline to eurozone banks and some better-than-expected economic data, particularly from the US.
However, we think US economic numbers are unlikely to keep providing pleasant surprises throughout the first quarter, while the initial enthusiasm for the ECB’s action may fizzle out if it is not backed up with other concrete measures to tackle the eurozone crisis.
While we maintain a cautious asset allocation, we are looking at ways of benefiting from any rebound in markets – for example, through buying call options – where we believe there is a favourable balance between risk and reward.
Bonds and cash
Bonds can offer a useful shelter from turmoil elsewhere, but we see little value for the long term. The fundamentals behind most government bonds are poor, yet these securities are also very expensive and, in our view, well overvalued. Within fixed income, we continue to favour high-quality corporate over government debt.
Given the high level of uncertainty, we believe the most prudent approach is to maintain a defensive equity positioning. While markets may rally in the short term, we are unwilling to bet that they won’t relapse. We are therefore sticking with a fairly low allocation to equities, and we maintain our preference for solid companies with strong balance sheets and high levels of free cash flow.
We remain comfortable with our hedge fund investments and continue to back talented hedge fund managers. Although recent returns have been mixed, global macro funds and other strategies that are uncorrelated to equity markets bring valuable diversification to investment portfolios.
Commodities and gold
The economic outlook is damaging sentiment towards commodities and we maintain an underweight position. We continue to hold large positions in gold as a hedge against turmoil.
For long-term investors, real estate remains attractive as a tangible asset with fairly predictable cash flows. However, we do not think now is the right time to be adding to positions and we therefore maintain an underweight stance.