Asset Allocator’s Soapbox: David Coombs on the attraction of equities

Rathbone Enhanced Growth Fund manager David Coombs discusses why equities still outclass bonds in this environment.

It’s certainly been an interesting month in which to go live with a high risk strategy fund, not to mention really put your money where your mouth is. We have been able to take advantage of opportunities that might otherwise not have existed.

Despite the turmoil, we still believe equities present less of a risk then bonds. It might go against conventional wisdom; indeed, what we are seeing now might represent the best buying opportunity we have seen for two years.

We have certainly used this as an opportunity to re-weight the equity portion of our portfolio, which now stands at 71% of the total. Our approach is a barbell one, and we have a preference for defensive, global large caps, with the superior growth emanating from our exposure to emerging markets and Asia.

We have used current market conditions to increase our emerging markets equities exposure (ex-Asia) to 15% (having originally tabled 10%), and will look to build our position in these markets to 35% in the medium term. We believe that in ten years’ time, the weighting to emerging markets in the MSCI World Index will more closely match their share of global GDP than current stock market capitalisations would suggest.

A political premium is still required, and another recession in the West could still be very painful for these markets, but relative valuations are now compelling, particularly for Indonesia, the Philippines and, selectively, Eastern Europe. Inflation could be close to peaking in many emerging market economies, resulting in interest rate hikes coming to an end.

Our other large equity position is our 24% allocation to UK equities. In light of the current market, we have committed 10% to an IShares FTSE 100 Tracker – a passive and ‘safer’ way to participate in any upside, bearing in mind those high levels of intra-day volatility which can make trading so treacherous. We have also been able to purchase a number of investment trusts, such as Edinburgh Dragon and HG Capital, which have been sitting on our target list, awaiting an attractive discount to NAV.

But we are holding a high cash position at around 15-20%, preferring this strategy to holding gilts and corporate bonds, where we believe risks remain to the upside.

Gilts appear oversold following the volatility in the equity markets, and we foresee negative real yields for some time. But we would not be surprised to see the yield on the UK 10-year rise by 100 basis points in three to six months’ time.

Over the next few months, we expect markets to remain unsteady and highly sensitive to negative and positive news. Today’s crisis (unlike that of 2008) is one of confidence in politicians and their ability to formulate a credible plan that will stimulate growth, and induce fiscal unity in Europe. There is no evidence of a liquidity crisis in the banking system yet, although solvency might be an issue.

But while the politicians dither, market volatility will continue. Within this, our central scenario remains continued growth in Asia and the emerging markets, while acknowledging the risks to growth forecasts for Western economies have clearly risen.