Investment: Why it’s time for an asset allocation rethink

Head of multi-asset investments at Rathbones David Coombs explains why it may be time to nudge your clients back into risk assets...

Is it time to rethink risk assets? We think so. By this we are not advocating a huge leap into ‘risk’, but a gentle nudge back into areas, such as the US and the emerging markets, that we feel offer the best value during the current volatility.
Recent unprecedented action by six central banks was a game-changer.

It illustrated that the US is serious about orchestrating a solution to the European crisis: indeed, it is no coincidence that Germany’s Chancellor Merkel and French President Sarkozy have since started to talk more openly about the possibility of fiscal harmonisation, as US Treasury secretary Timothy Geithner lurks in the wings.

Clearly, it is going to be far from a smooth ride, but this is the first time we have seen the politicians on a course for a structured solution to the mess.

It is always dangerous to predicate too much on the promises of politicians, but the German index, the Dax, has trailed and is behaving like the ‘high beta’ market. This means if there is a recovery, then it should outperform, and we believe our exposure to the Baring German Growth Trust continues to offer us sufficient exposure.

Increasing risk

Overall, the encouraging noises out of Europe and elsewhere have led us to increase risk tentatively in various strategies via a barbell approach. This has translated into a reduction to zero in long/short equities and a recycling of those assets into our US equities weighting, based on a flow of good economic data.
Furthermore, we have increased ‘beta’ by adding to emerging markets.

Given their relative underperformance in 2011, emerging markets are now trading on a multiple of around 11 times earnings, and we believe this represents good value. A notable exception to our reallocation is the UK, where we remain heavily underweight. The UK is still looking vulnerable, given its level of exposure to Europe, and hence our preference for the US.

We have also sold out of gold in our defensive strategy, as the yellow metal has started to shift away from its status as a safe haven and has become increasingly correlated to equities.

Parts of the bond market are also looking attractive, particularly some high yield and investment grade corporates. We think it is wise, however, to remain underweight duration, on the premise that inflation is likely to remain higher in the short term.

Macro ups and downs

At this juncture, we believe ‘Merkozy’ will pull the rabbit out the hat, but are wary that this is still a binary bet. However, we are also very aware of the fact that while attentions are fixed on Europe, trouble is brewing in Iran, which could well drive up the oil price over the coming months. We will therefore be looking to hedge out this risk in our portfolios.

To end on a brighter note, the market is now discounting a recession in Europe (or is certainly more optimistic about the extent of a slowdown). For this reason, we believe next year might herald more opportunities to take advantage of any cyclicality.

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