Seven asset allocation themes for 2012

Philip Saunders and Max King from the Investec Global multi-asset team give their predictions for the year ahead.

1 Corporate debt: returns should 
be reasonable

Corporate spreads rose in 2011 despite improving corporate finances whilst falling yields on government bonds kept returns positive. Corporate spreads should fall in 2012 but government bond yields should rise. Therefore returns from medium and high yield bonds should be good but investors will need to keep duration short for higher quality bonds.

2 Emerging markets currencies and debt are attractive

Many currencies reached expensive levels in 2011, heralding a setback for local currency emerging markets debt. We think that setback provides a renewed investment opportunity with better value now apparent in currencies while the outlook for debt is improved by the peak in inflation and interest rates.

3 Quality stocks will continue to 
out-perform

Investors continue to be tempted to invest in ’value’ or ‘recovery’ stocks (such as banks). While there may be selective attractive opportunities in these areas, the best returns will be earned from high quality companies on only reasonable valuations, but with sustainable growth.

Megacaps, on average, are likely to continue to under-perform while the long term trends favour quality mid- and small- caps. The best stocks to buy may still be the ones you wished you had bought a year ago.

4 Emerging market equities return to outperformance

After a disappointing year, continued earnings growth has re-established excellent valuations in absolute terms and attractive valuations relative to developed markets. A peaking of inflation and interest rates should be positive for most economies and any setback to growth in China will only be temporary.

Fund outflows from emerging markets should turn into inflows as the outlook improves. Currencies appear reasonable value and markets which looked expensive, such as India, have come back sharply.

5 Resource equities

The outlook for commodities may be subdued but we think the opportunities in equities are plentiful. The growth in natural gas and shale oil production both in the US and globally is transforming the outlook for energy and offers particular investment opportunities.

A slow-down in China threatens demand for certain commodities in the short term but structural change is supportive in the longer term. Mining companies face the challenge of resource nationalism but the opportunity of bringing new production on stream.

6 Decades of economic convergence

Has brought hundreds of millions of new consumers to the market. In 2012, consumer spending will remain strong in emerging markets, particularly in Asia. This buoyancy will be driven by technology, consumer brands and luxury goods.

Consumption in the US will continue to pick up, driven by low interest rates, falling inflation, improving housing conditions and stabilising economic outlook. The longevity of global brands will continue to justify higher valuations.

7 Volatility

Volatility is likely to be a permanent feature of markets as a result of enduring nervousness following two massive bear markets in the last decade, computerised trading, the shrinking of broker positions, the decline of the specialists on the NYSE and the abolition of the up-tick rule governing short trades.

Investors need to either look through short term volatility in making long term investments or use it to their advantage by buying when volatility is high and reducing when investors are complacent.

We think it is better to be in markets and accept the volatility than miss out on long term opportunities. Market timing is not getting any easier and managers that depend on this for their returns are set for a lean period.