As­set al­lo­ca­tion: over­weight global eq­ui­ties

Financial Mirror (Cyprus) - - FRONT PAGE -

Af­ter the euro sum­mit about Greece on 12 July, things moved more quickly to­wards clar­i­fi­ca­tion. De­clin­ing un­cer­tainty was seen as pos­i­tive for risky as­sets. Af­ter hav­ing taken prof­its on our long du­ra­tion po­si­tion in core eu­ro­zone gov­ern­ment bonds some time ago, we felt it time for an over­all re-risk­ing. Sup­port­ing this ra­tio­nale was our ex­pec­ta­tion of bet­ter eco­nomic growth in the in­dus­tri­alised world and, even with a Fed rate hike likely later this year, a still ac­com­moda­tive mon­e­tary en­vi­ron­ment. We have thus gone over­weight in global eq­ui­ties. The ad­di­tional ef­forts by the Chi­nese author­i­ties to sta­bilise China’s eq­uity mar­kets con­trib­uted to a much more pos­i­tive mar­ket risk sen­ti­ment, which has been un­der­lined by the sub­se­quent sharp plunge in volatil­ity.

This also sup­ports the ex­pressed ear­lier in our com­men­tary on Chi­nese eq­ui­ties and our avoid­ing an un­der­weight in emerg­ing eq­ui­ties, be­cause it is one of the few broad as­set classes that, in our opin­ion, is still at­trac­tively val­ued. The out­look for growth is cloudy not just in China, but in nu­mer­ous other coun­tries. So we think it is too early to con­sider an over­weight in emerg­ing mar­ket eq­ui­ties on val­u­a­tion grounds.

We pre­fer to be ex­posed to the at­trac­tive val­u­a­tions of emerg­ing eq­ui­ties via emerg­ing Asia, which we be­lieve of­fers good value and qual­ity. Un­der­ly­ing earn­ings in Asia are on a par with de­vel­oped com­pa­nies’ earn­ings; mon­e­tary and fis­cal poli­cies are more sup­port­ive and we be­lieve in the re­gion’s re­form progress. We are over­weight Asian emerg­ing eq­ui­ties ver­sus broad emerg­ing eq­ui­ties. Since we in­vest in MSCI in­dices, our ex­po­sure to Chi­nese do­mes­tic shares, which have made much larger moves than Chi­nese shares traded in Hong Kong, is lim­ited. So we did not ben­e­fit on the up­side, but we also did not suf­fer from the cor­rec­tion.

We ex­pressed our con­cerns about China by go­ing un­der­weight in emerg­ing mar­ket debt de­nom­i­nated in US dol­lars. This as­set class has ben­e­fited from the search for yield among in­vestors and has seen stronger in­flows than emerg­ing mar­ket eq­ui­ties. In an en­vi­ron­ment of fad­ing liq­uid­ity, a lower ap­petite for this as­set class leads us to con­clude that emerg­ing mar­ket debt is at risk of be­ing the tar­get of ‘hot money’ flows. This could be even more the case for cor­po­rate debt, which makes up about 20% of our in­vest­ment uni­verse.

As said, val­u­a­tion-wise, emerg­ing eq­ui­ties (par­tic­u­larly Asian) of­fer value in an oth­er­wise ex­pen­sive range of as­set classes, while emerg­ing mar­ket hard cur­rency debt is neu­tral. It of­fers no yield pickup over US credit with com­pa­ra­ble rat­ings and there is a risk that yields will rise in the US once the Fed starts tight­en­ing. Lo­cal cur­rency debt has been bol­stered by re­cent cur­rency de­pre­ci­a­tions as the for­eign ex­change el­e­ment has added to its ap­peal. Fi­nally, lo­cal cur­rency debt has lagged emerg­ing eq­ui­ties by more than hard cur­rency debt, while his­tor­i­cally, the two as­set classes have been closely linked.

Within Europe, we kept an over­weight in high-yield cor­po­rate bonds for fun­da­men­tal and carry rea­sons. We are over­weight small caps ver­sus large caps in Europe, which is re­lated to our pos­i­tive view on where Europe is in the eco­nomic cy­cle rel­a­tive to emerg­ing economies. Thus, we are ex­posed to Euro­pean as­sets, but the ex­po­sure is some­what hedged by our short euro po­si­tion ver­sus the US dol­lar.

In com­modi­ties, we don’t yet fore­see a turn­ing point in prices, and prices have fallen to very low lev­els. This level of val­u­a­tions lim­its the fur­ther down­side po­ten­tial for com­modi­ties so we have closed the un­der­weight in com­modi­ties.

In our flex­i­ble multi-as­set po­si­tions, we im­ple­mented a con­ver­gence trade by go­ing long US Dol­lar high yield debt ver­sus credit de­fault swaps, be­cause the spread dif­fer­en­tial and spread ra­tio are at­trac­tive.

We have a long po­si­tion in the Ja­panese yen ver­sus the euro and the South Korean won to hedge China-re­lated risk. The yen is tra­di­tion­ally a safe haven cur­rency in pe­ri­ods of trou­ble. We don’t see any signs that the Bank of Ja­pan will try to weaken the yen fur­ther through an in­crease in its quan­ti­ta­tive eas­ing. Given high ex­po­sure to China and do­mes­tic weak­ness, the Bank of Korea may cut even rates fur­ther at some point.

We are over­weight the US con­sumer dis­cre­tionary and in­for­ma­tion tech­nol­ogy sec­tors, which should ben­e­fit from ris­ing con­sumer spend­ing.

We are pos­i­tive on the out­look for Ja­panese credit and long 5-year for­ward US in­fla­tion swaps.

We are long the cheap Mex­i­can peso ver­sus the strong Bri­tish pound and long the US dol­lar ver­sus the over­val­ued Swiss franc.

We are long the yen ver­sus a 50/50 split of the US dol­lar and the New Zealand dol­lar. Our val­u­a­tion mod­els in­di­cate that the yen is cheap ver­sus both cur­ren­cies and, faced with weak eco­nomic data, the Re­serve Bank of New Zealand re­cently had to abort its hik­ing cy­cle and started to cut rates in July. As in Aus­tralia, the cen­tral bank would like to see a weaker cur­rency.

Just as in our core al­lo­ca­tion, we are short the euro ver­sus the US dol­lar.

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