Double-dip concerns
He draws parallels to the ‘risk-on, risk-off’ period between 2010 and 2012. “A lot of the same things are around today. We do not have a euro crisis but w e definitely have double-dip concerns and we need more evidence that the US economy is basically doing alright and consumers are enjoying their windfall, and that the powers that be in China are in control,” he says.
In terms of general equity beta, the multi-asset team cut back on its equity exposure during last August’s sell-off – equities were cut down from around 50% to 30% of the portfolio. Saunders says he struggled to find growth assets that were attractive.
However, since then his stance has softened and the team is increasingly seeing value in re-pricing assets, most of which were previously beneficiaries of quantitative easing, such as emerging market FX and debt, and high-yield bonds.
Says Saunders: “These are areas we had been avoiding because we felt the value was poor and the macroeconomics were very negative and they were intrinsically high risk. But they have moved a long way. That is not to say they cannot move a bit more – there is always that final kick-in that gets you – but they have got to a point at which, provided you are selective, there are some pretty attractive things to own.”
He has selectively added to emerging market debt and currency positions, for example, the Indian rupee and Brazilian real.
The team has also started to venture back into Chinese H-shares, buying individual high-quality service sector-focused names. These are trading on very low multiples with decent earnings, though have been beaten up with the Chinese equity market at large.
Saunders adds: “Ultimately, I suspect we will be skewing our equity exposure more towards emerging market equities, but operating earnings are ghastly in most areas. Valuations may be OK but the macro dynamics are negative because you have got a highly deflationary environment.
“We would love to own Indian equities on a long-term basis but that is where everybody is crowded. The problem with emerging market equities, with the exception of China, is the high-quality stocks that should be core positions in portfolios on a multi-year basis are trading pretty expensively.”
Another contrarian opportunity Saunders talks about is CCC-rated bonds. He says: “These are at the junkier end of junk bonds but it is interesting that they were the canaries in the coal mine – they performed phenomenally as a major beneficiary of quantitative easing but then they hit a peak and started to deteriorate. They now have a pretty substantial risk premium on them, much larger than mainstream high-yield bonds.
“Sometimes the supposedly intrinsically riskiest part of the market is actually the least risky if the risk premium over compensates you.”
