Asset allocation insights for a messy world
You need only spend 30-minutes browsing current economic, political and social news to realise the world is a right mess. South Africa is at war with crime and corruption, low economic growth, unemployment and a ruling elite that is more concerned with lining pockets than addressing social ills. Further afield, the United Kingdom, United States, and much of the European Union cannot figure out how to stop floods of economic migrants from knocking their respective economies for a loop.
The Biden versus Trump debacle
In the US, the electorate is preparing to choose between a soon-to-be-convicted septuagenarian Republican or a bumbling and stumbling octogenarian Democrat. Meanwhile, the British are trapped between two political ideologies that have long since lost the ability to implement policy. Forgive the flippancy, dear reader, but whichever way the UK citizenry votes, the criminal class will sleep peacefully. In that country, you are more likely to do jail time for tripping up over your pronouns or posting something non-PC on your favourite social media account; drifting over the channel and burning your passport on the beach when you arrive gets you a lengthy stay in a three-star-or-better hotel.
Apologies for the wordy introduction; the point of all of this is you still need to figure out which geographic region offers the best return for the offshore component of your and your clients’ investment portfolios. To find answers, FAnews attended the 2023 Morningstar Investment Conference, and more specifically, a panel debate tasked with ‘rethinking global investing’. Debra Slabber, Director and Portfolio Specialist at Morningstar Investment Management introduced the topic, saying that asset allocation was more difficult now that equities were no longer the only game in town, and that the era of ‘free money’ was something of the past. “Where are we going to make money for our clients in the next decade?” she asked.
The US on a narrow path to a soft landing
Gurpreet Gill, Macro Strategist at Goldman Sachs Asset Management, tacked the first question from a US perspective. “Our base case expectation is that the US is still on a narrow path to a soft landing; overall the US economy is looking resilient, she said. The ‘soft landing’ scenario depended on the US achieving a slowdown of economic growth through policy tightening; a rebalancing of the labour market; wage growth; and lower core services inflation. Progress has been made on each of these points, with some considered ‘done and dusted’.
Slabber then interrogated Gill on the impact of “one of the fastest rate hiking cycles in history” on US fixed income, and specifically the possibility of widespread debt defaults in that economy. “The US high yield market is of higher quality today than it was in the past,” said Gill, dismissing the default scenario out-of-hand. She offered two reasons for asset managers’ confidence in US corporate debt. The first is due to the number of investment grade companies that have entered the high yield space recently, and the second is the double-whammy of defaults experienced around energy in 2015 and post-pandemic in late-2020.
From an investment perspective, Goldman Sachs is still overweight US credit, favouring investment grade bonds that offer a respectable 5-6% yield. “As time goes by, you will have to be increasingly selective; active bond selection is key … you have to look bottom-up at every balance sheet to identify firms’ resilience and their capacity to navigate the cyclical environment,” Gill said.
Slabber then asked Sean Neethling, Head of Investments SA at Morningstar Investment Management what factors fund managers were considering when building multi-asset portfolios for their clients. “When we look across high yield and investment grade bonds, whether in Europe or the US, we do not necessarily think that the spreads have opened up enough to offer compelling value,” he said. He warned that the US high yield investment grade debt had “largely repriced off the back of benchmark rates resetting”. Even so, high yield debt offered slightly better value on a relative basis to cash and treasuries.
The dislocation of equity markets
James Bullock, Portfolio Manager at Lindsell Train was then put on the spot to explain the dislocation of equity markets, and reflect on which geographic regions equity managers should be overweight in. “We are underweight US equities, and underweight US tech in particular,” he said, issuing a blanket warning about how concentrated global financial markets were presently. Case in point, the seven biggest US tech companies account for almost 20% of the global equity index. Investors were also warned that it was incredibly difficult for portfolio managers to identify winners and losers in the context of disruptive change, in turn being driven by the rapid and widespread adoption of artificial intelligence (AI).
For Bullock, tomorrow’s winning stocks must be able to pass on inflation to their end-customers; there are countless examples of companies with strong brands that have posted consistent double-digit growth and shown resilience despite myriad recent challenges. As for where these companies are domiciled, Lindsell Train said they liked Japan, which was described as a fascinating market. “We are stock pickers at heart, able to go market by market [without] necessarily taking a view as to how attractive that market is,” Bullock said. To expand on this concept, he noted that an investor seeking exposure to the PC gaming trend would be well-served by Nintendo, which just happened to be a Japan-domiciled company.
Risk and return featured strongly throughout the panel discussion. “The most important thing is for investors to reframe the way they think about risk,” said Neethling. “The simplest definition is that more things can go wrong in an environment like we have today, compared to what actually do go wrong”. He concluded that asset managers and financial advisers should ensure that their clients followed appropriate investment strategies, choosing funds with the right types of mandates: “The one thing we can control is making sure that clients are aligned in terms of their investment objectives and constraints”.
Central bank policy could diverge from here
According to Gill, the world has come through a multi-year period of coordinated central bank policies. Central banks acted similarly in their tightening efforts, following a coordinated period of easing when the pandemic hit; but now investors can expect a divergence in terms of when central banks hit their peak interest rates, when they decide to pivot to interest rate easing, and the pace of that easing.
The UK and US will respond differently based on how sensitive their economies are to interest rates. The post-pandemic world is all about resilience. “On a geo-economic stage [we focus on] the resilience of supply chains; and in your clients’ portfolios [your focus should be on] resilience against downside growth risks,” Gill concluded, adding that bonds are back with a vengeance in the current economic environment and will play a role as core elements in fixed income portfolios.
“There is a lot of optimism out there,” said Bullock, reflecting on a US market that was up double-digits year-to-date end-September 2023, and up 15% or more in four of the last five years. Against this backdrop, investors may wish to proceed somewhat cautiously. “The average long-term return from US markets is closer to 9% per annum; but that does not mean you should veer away from equities,” he concluded. “Inflation has devalued the dollar by 90% over the last 50-years whereas at the 9% per annum you have enjoyed a 200-fold real return in US equities over that same period”.
Writer’s thoughts:
The key thread in this Morningstar panel discussion was that your clients’ risk and return objectives, and the yield on the asset classes within their portfolios, were possibly more important than the geographic mix of assets. Agree or disagree? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za
