News & views

29 November 2011

Investment update

Financial markets continue to suffer from a lack of confidence amongst businesses, consumers and investors. Bearishness is everywhere, and arguably asset prices have done well to hold up to the extent that they have, given the flows of money away from the markets, which have been exacerbated by indiscriminate selling by European banks as they de-lever and try to avoid insolvency themselves.

The advantage in such conditions is that there is severe mis-pricing of asset classes and within asset classes, and to an extent not seen since 2008. Even the most basic index investor might consider that he could harvest decent returns from here, if only in knowing that the best times to invest are always when it feels most wrong, or as Baron Rothschild put it (later popularised by legendary investor Sir John Templeton) "buy when there is blood in the streets".

Nevertheless, there are of course valid reasons for the prevailing negative mood amongst investors. The US economy has skirted around recession for the time being, and news from China is no worse than mixed, so instead the epicentre of bad news is once again the Eurozone. Our view here remains the same as it has been all year. That is, that the ECB will, when all else fails (as it will), "print" money, or find some other way of standing behind Eurozone government debt. It was always going to be a painful ride getting to this point, and we have had every expectation that many if not most European banks would end up nationalised (or some such other).

Angela Merkel hopes to have enacted some Eurozone treaty changes before unleashing the ECB's printing presses, and these should be announced shortly. When this event does occur, we expect it to be extremely bullish for risk assets, certainly in the short term, and it will take much of the uncertainty discount out of markets. It will be a time to be invested, and within our multi asset class portfolios we will have sufficient exposure to risk assets to benefit. Meanwhile the volatility of financial markets and having the Eurozone travails as front page news, does wear down investors who have a tendency to get thrown from the rodeo ride at the worst possible times (and conversely are drawn to investing near market tops, when it is "safe" to do so). And this is as true for many professional investors as it is for private investors.

So, what have we been doing with the portfolios? Well, although we have been looking through to the other side of this crisis, we have still made some minor adjustments. Earlier this autumn we introduced some more flexible funds into, for example, our Asian equity exposure. These are investments that should outperform in times of volatility, and will have an element of downside protection. They have made a very good start to life in the portfolio. Additionally, we have let the portfolios' asset allocations "drift" with the markets, which means that the weighting towards risk assets has fallen a little, in line with prices. Ordinarily we would be looking to rebalance back up to target weights, but given the political risk at this time, and the caution urged by technical indicators, we are yet to do this. Again, this has worked in our clients' favour. Finally, we have moved portfolio cash from sterling into dollars, on the basis that further Eurozone pain is likely to infect the pound to some degree, while the US dollar will benefit as a safe haven, at least in the short term. We have also allowed this cash element to rise slightly, as we are not reinvesting new flows into the market, until we are through the worst of this treacherous period.

We do not move wholesale into or out of markets and the reason for the difficulty level in this methodology is that it is akin to investing in an accumulator at the race track. You only need one leg of the bet not to come off for the whole project to prove damaging i.e. every time you exit the market, you must time this right, but equally you must then time your re-entry right as well, and so on.

In the meantime we continue to build value into the portfolios and are excited by future prospects. At the moment, for every £10 we have invested in equities, our portfolios are entitled to about £1 of corporate earnings – it is worth bearing in mind that companies have never been more profitable than they are today. We do diversify into other strategies and asset classes, but we do not have a huge exposure to bonds right now, especially government bonds, which are no longer "risk free" assets. Naturally we do have some exposure there, as befits a true multi asset class strategy. However the £10 you can invest in a 10 year gilt will only yield you 22 pence. £10 invested in cash will likely be something similar. We have a bias in our bond exposure to Index-linked (inflation protected) bonds, but even there one is actually only entitled to a yield of less than inflation. So one is very much paid to be a valuation based contrarian investor at the moment, which is especially helpful as that is indeed our philosophy.

If you would like to learn more, please speak to your usual contact at Towry.

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