Diversify offshore to guard against the volatility that lies ahead for financial markets

With quantitative easing and ultra-accommodative monetary policy to be wound down at some point; investors should expect an increase in financial market volatility.

Liang Du, Head of Asset Allocation at Prescient Investment Management, noted that policy changes inevitably introduce volatility to markets, adding that the winding down of monetary policy programmes would be a good thing since the step would be intended to allow real economic demand to replace quantitative easing. This would mean that economies were showing signs of cyclical recovery.

“With regard to monetary policy, the Federal Reserve has been consistent in its approach, always maintaining that it will do what’s determined by the economic data. Risks in the US economy have diminished and there are signs of recovery, particularly in the housing market. The leading indicators are pointing the right way,” said Du.

He added that Europe, having scored an own goal with austerity, was also starting to move towards growth orientated policies. A recovery in the US would help the euro zone.

On China, he said a change in mindset was required.

China was likely to achieve a growth target of around 7% this year but investors should get used to lower growth over the next decade.

Said Du: “In future, the Chinese economy will be driven less by demand from European and US consumers and more by Chinese consumption. As the country moves away from being an export machine, growth is likely to slow. However, even at 4%, growth current valuations mean China is a great investment opportunity.”

Where global equities are concerned, Du said the low inflation environment and low interest rates should support prices. “However, valuations are on the expensive side, but not screamingly so. Valuations have definitely gone past neutral and there is not as much fear in the market.”

Developed markets are doing well, but global sentiment towards the BRICS countries is very low. Indicative of this is that China is trading at almost half the value of the US, with a P:E ratio of around 10 versus 19 for the US. Both markets have experienced flat earnings growth over the last 18 months.

Looking at asset classes, Du said he favoured equities over bonds and cash for now. That, however, was starting to change with bonds catching up.

On the home front, he said that because foreign investors hold a high percentage of SA bonds and equities (around 40% compared with between 20% and 30% in other emerging markets), domestic markets will remain vulnerable to the whims of foreign investors.

However the rand is on the cheap side, being one of the weakest currencies in the past year compared to its peers. Although over the near term weak country fundamentals make the rand susceptible to a crisis, asset allocation over the longer term should not count on the rand depreciating at the rate it has recently.

”But we continue to consider offshore investments a good idea due to the opportunity they present for diversification. Investors should invest offshore directly to avoid an extra 1% a year in fees due to the extra layer represented by the convenience of feeder funds,” advised Du.