Medium risk portfolios: Treading softly but buying on weakness
Managers have been tasked with making some big calls on equity allocations, while also balancing currency risks
Gary Shepherd
For medium-risk portfolios, private client managers have historically opted for around half of assets in equities. However, a prevailing mood of caution during the third quarter, alongside concerns about valuations in risk assets, means investors are having to tread more carefully.
For Brooks Macdonald’s medium-risk mandate, equity risk exposure during the quarter was at between 57% and 60%, compared with a normal range of 55-75%. This included a neutral-to-positive position on the US, with underweights to the UK, emerging markets and Europe.
Capital protection
“We believe we will remain in a low growth, low inflation, low interest rate environment for some time,” says Brooks Macdonald’s chief investment officer Kevin Boscher.
“We would like to put cash to work in productive assets but in Q3 we felt we needed to be more tactically defensive, protecting capital should some of the risks dominate and we see a sell-off in risk assets.”
However, the wealth manager has taken advantage of weakness in certain markets, by putting cash into international thematic strategies. “Our rationale is that once Trump gets in he is likely to focus on reflationary policies, which would include tax cuts, spending on infrastructure and defence, and trying to persuade US corporations to bring some of their huge cash balances back home to invest in the domestic economy, or at least to increase shareholder returns.
“If successful, we should see stronger US growth, higher inflation and higher short- and long-term interest rates.”
In fixed income, Brooks Macdonald holds around 20-22%, with a heavy bias towards credit markets over sovereign bonds, while using strategic bond managers to take advantage of discrepancies in markets.
Boscher says: “Towards the end of the quarter, we started to see sovereign bond yields move higher in anticipation that we might get a shift in policy towards fiscal easing in the US, UK and Japan. Some central banks were starting to question the effectiveness and limits to their monetary policy, which made us cautious.”
Edward Loader, director of discretionary investment management at Royal Bank of Canada, expects to see a divergence in monetary policy across the world, and with it more volatility than investors have become accustomed to. This volatility, he says, will be most visible in currency markets, which will continue to be a driver of returns, as we have seen in 2016.
Diversification boon
“Of course, there is also the political uncertainty and a risk of too much optimism over the US election result, which markets have quickly priced in, and elections across Europe before and after Article 50 is expected to be triggered in March 2017 have potential to rock the boat,” he says.
“We anticipate investors will see more benefit from full diversification across asset classes and regions than they have done in recent years.”
Currency calls have again played a huge part in asset allocation decisions during 2016, with Boscher having highest conviction in the dollar, which he says is most likely to strengthen against other major currencies on a trade-weighted basis.
He says: “As sterling investors we have been relatively happy to have significant exposure to dollar assets. Also, from a sterling perspective we must understand that it has been oversold with sentiment very negative.
“If Brexit doesn’t turn out to be as bad as some people fear, sterling may rally in the shorter term against most major currencies. We have less conviction in the euro and yen, running those positions on a hedged basis.”
Loader says he typically controls risk in fixed income and alternative allocations by using funds that offer a currency hedge, and also favours hedging Japanese equity holdings to dollars.
