Passive risk
Aside from an overdependence on bullish macro data, another reason we believe asset prices have inflated to current levels is the mass inflow into passives.
Those who have read my previous columns will know my thoughts on the mass inflows into ETFs that we have seen over recent years and the negative impact this could have on markets. As more and more investors buy into passives, hot money flows into the same few large-caps and pushes prices to eye-watering levels.
This could mean that, when the next negative piece of economic data comes out or a Black Swan event rears its head, passive investors might leave en masse and this really could sting anybody who is left in the market.
Look to EMs
So what can we do? Grantham suggests holding as much emerging market equity as possible because, unlike most developed markets, EM boasts more attractive long-term drivers than most investors believe.
This is a view we share and, while global GDP growth is synchronised for the first time in years, there are certainly emerging market regions boasting more solid long-term growth drivers than others.
A prime example is India, which has seen its economic data improve since the election of pro-economic reform prime minister Narendra Modi in 2014.
While its equities may look toppy at first glance, investors should note than Indian equities are always expensive relative to their emerging market peers because of their strong fundamentals and, in fact, are looking significantly cheaper than rallying Chinese equities at the moment.
While it is taking a while for some of these reforms to come through, we believe this could remain a very positive driver of the country’s economic growth over the medium to long term.
Funds to pick
Examples of Indian equity funds that we like include Stewart Investors’ Indian Subcontinent or Goldman Sachs’ India Equity Portfolio.
For investors who want to hedge their bets slightly, a global emerging markets fund with an Indian equity overweight – such as Charlemagne’s Magna Emerging Markets Dividend – could be a good option.
Grantham also suggested having a small hedge of some high-momentum stocks either in the US or China. In these countries, investors may wish to consider the likes of Axa Framlington America Growth, Schroder US Mid Cap and First State Greater China Growth.
I believe it’s prudent for investors to keep an eye on rising markets and to brace themselves for whatever may come over the next couple of years. Whether or not a “market melt-up” and subsequent sell-off is on the cards, it will pay to tread carefully and remain selective.
