Credit and equity divergence presents opportunity

Michael Spinks, Co-Head of Multi-Asset at Investec Asset Management, explains why we are likely to see a divergence in performance between credit and equity as we continue into 2014, and outlines where he sees opportunities for multi-asset investing.

Interest rate expectations have failed to rise significantly, despite some much stronger economic data, surprising many in the markets. This is because inflation has been subdued, even while stronger data continues to come through, thus keeping a cap on rate expectations. However, we expect to see interest rate rises as the year progresses.

A lack of movement on interest rates for the past eight years has changed markets’ behaviour, with two major implications if changes in interest rates were to occur.

The first is in credit markets, in areas such as high-yield, where investors have been searching for income and have been forced up the risk spectrum. In our view, a change in the price of the risk-free assets, and the higher return from assets such as cash, will impact the price of assets such as high yield, notably at the time when the fundamentals of those assets are weakening.

Secondly, we believe that equity markets would be impacted, given that interest rate increases would take place against a background of a firmer growth outlook – an overall positive for equity earnings. This may lead to a divergence between the performance of credit and equity areas of the market.

In addition, volatility in markets has been suppressed by central bank action, leading to the market overpricing the certainty attached to the future path of interest rates. We believe volatility is likely to increase, with interest rate expectations re-pricing as we go through the year.

Opportunities in emerging markets, energy

Our portfolio positioning has evolved over the course of the year, maintaining a broad range of growth asset exposure retaining a growth bias, and within that an equity bias. To this, given the stage of the cycle and the more meagre risk premia available, we have added a number of selected valuation-led opportunities. Notably within emerging markets we have added debt exposure in Brazil and some EM currency exposure through Mexico and the Indian rupee, and in equity markets we have increased our exposure to the energy sector.