Multi-asset fund managers are continuing to slowly reduce risk positions in preparation for a recession that could, according to Investec’s John Stopford, be anywhere from 12 to 36 months away. But they are not quite ready to be outright defensive just yet.
The current bull market is pretty long in the tooth now. In fact, Bank of America Merrill Lynch notes that we’re less than 14 trading days away from the S&P 500’s bull market becoming the longest of all time.
Stopford accepts that we’re pretty late in the cycle. Mark Appleton, head of multi-asset and strategy at Ashburton Investments, points to risk factors like the reversal of easy money, trade wars and global growth that has become desynchronised.
And Tommaso Mancuso, head of multi-asset at Hermes, says we’re seeing plenty of signs of “typical end-of-cycle optimism”, with US stock buybacks ramping up on the back of tax reforms. Momentum has resumed in earnest after the first-quarter correction.
Bill McQuaker, portfolio manager on Fidelity's Multi Asset Open funds, sees the divergence of global growth reconciling itself. But he reckons it’s more likely the US will slow towards the rest of the world, rather than the rest of the world catching up with the US.
“Headwinds like oil prices, long-term policy rates and the stronger US dollar are all headwinds for the US as well,” he says. “Once the positives like tax cuts begin to recede then the likelihood is that the US will slow. The last month’s data is beginning to hum that tune.”
Markets Could Rise Further
However, few believe the bull market is over just yet. “If you look at leading indicators, a recession globally is somewhere between one to three years in the future,” Stopford says. And Mancuso notes that equity markets could yet hit further record highs before the year is out.
As a result, Stopford says his ‘growth’ bucket of assets is still very much in equities. “At this stage in the cycle we think equity still has upside and downside, whereas something like credit looks like it’s mostly got downside.”
And, of course, “the last year of a bull market can be pretty rewarding”. “We don’t necessarily want to walk away now if there’s more upside.” While credit looks to have peaked already, Stopford adds that equities don’t tend to peak until around six months before a recession hits, “so there’s still a bit to go”.
Appleton now has a marginal underweight in global equities and has lessened his exposure to emerging market debt. Mancuso has taken his portfolios’ leverage down closer to 4% volatility, rather than 6%.
Stopford’s Investec Diversified Income portfolio is the most defensive it has been in the six years he's been running it. He’s gone from having a “clear growth bias” and a beta – a measure of volatility – to equities of a third, or 1.33, to a much more defensive beta of 0.1.
Are Bonds Still Sufficient Diversifiers?
Stopford's team views diversification differently from the traditional equity/bond split: “Just because something is called a bond, doesn’t mean it’s a diversifier with an equity. What matters is how it behaves in times of change.”
Government debt has been distorted by central banks’ quantitative easing policies since the financial crisis. As that extraordinary monetary policy gets reversed, there’s a question mark over how defensive debt will be.
Stopford says: “There’s definitely one scenario where, in the same way QE pushed all asset prices higher, the withdrawal of QE potentially causes all asset prices to sell off, so your bonds are no longer negatively correlated to your equities.”
Therefore, his exposure to this traditional diversifier is used sparingly. He has positions in Australia, New Zealand and towards the longer end of US Treasuries. David Coombs, head of multi-asset at Rathbones, also has a position in safe haven Australian bonds.
Which Other Defensive Assets Are Favoured?
One traditional safe haven that seems to still be liked is the Japanese yen. Appleton says he has an overweight to this currency and deems it “an efficient risk-off currency”.
Stopford agrees and has around 5% of his portfolio exposed to the yen, which he says is a “naturally defensive” asset.
McQuaker also likes the yen, and has exposure to another traditional safe haven asset, gold, through the iShares Physical Gold ETC (IGLN) and Investec Global Gold.
Appleton reckons the yen is “a cheap way of hedging our portfolio construction, instead of using derivatives”. But Stopford disagrees, arguing that options are cheap in the current environment.
He also has both call and put options on equity markets, which act as insurance against his 29% physical equity exposure.
Stopford explains what this means in practice: “If the market collapsed tomorrow, our sell options mean the portfolio would behave as though we’ve only got nine or 10% in equities. Our call options mean if the market rallies quickly, our portfolio begins to behave as though we’ve got more like 30% in equities.”
