Growth assets – yes, they do exist
No asset currently offers value. A recession is at hand. Cash is King.
These views are held by many investors, but how accurate are they? David Vickers, senior portfolio manager at Russell Investments, told participants at yesterday’s Adviser Sphere event, that many assets do look expensive. But not all by any means, and opportunities are rife for skilled investors.
Mr Vickers acknowledged that global equities and government bonds are above fair value. His Multi-Asset fund has reduced its exposure to equities and increased cash holdings over the past 18 months.
“Despite $7tn pumped into the economy, we have not had much response,” Vickers said. The earnings outlook for global equities now looks far worse than any time in the past three years.
However, while the US market is expensive on most measures, Europe and Japan are close to fair value and emerging market valuations are considerably below fair value. “There are huge divergences, so opportunities still exist,” Vickers said. Even in expensive markets tactical allocation – essentially selling the rallies – can add value to the portfolio.
The good news for global markets – although it may sound counter-intuitive – is that investor sentiment is closer to panic than it is to euphoria.
“Market rallies don’t end with panic, they end with leverage and euphoria, and we don’t see that now,” Vickers noted. “So markets should push ahead in the short term.”
There is less to be bullish about in government bond markets. The 30-year bull market in bonds has consistently defied predictions of a correction, said Vickers, but every time yields fall, the risks crank up a notch. “Even small moves in yield can lead to a large capital loss,” he warned.
But hold on, how is all this helping investors? Knowing what to avoid is less than half the story. Here’s what Vickers does like.
First, convertible bonds. The options embedded in them provide an asymmetric profile, meaning convertibles have participated in 71% of the rise in equity prices on average, but have participated in only 59% of the drop in prices. “Adding convertibles builds resilience and defensiveness,” said Vickers. However, they are shunned by some investors because of their perceived complexity – they are essentially an equity, a bond and a derivative all in one. “Many investors avoid them. But it’s a deep market and they are great for the portfolio,” says Vickers.
In fact, asymmetric bets in general are favoured by Vickers. He likes the insurance aspect of them as well as the return potential. “As something gets more expensive, the price to insure it gets cheaper. We insured 10% of our equity portfolio for just 12 bps. It makes sense to have insurance in the portfolio. If we are wrong, we only lose 12bps, it’s not a big price to pay.”
Vickers is also a fan of high yield, where he sees few signs of a sizeable uptick in defaults. However, spreads on US high yield have compressed to levels where it no longer offers value across the board.
Overall, Vickers expects a positive, albeit historically low, return from risk assets in the medium term. His views in a nutshell:
- We do expect a positive (albeit low) return from risk assets, it just comes with additional volatility.
- Dynamic asset allocation means an increasing focus on capital preservation. Hence, “selling the rallies”
- Create asymmetry so we can be there for the upturn.
- We believe in convicted diversification. Be sure what you have in your portfolio is really what you want.
- Alpha generation opportunities are higher than for some time. Owning Unilever is popular, but how much value is left in that trade?