This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Tom Becket CIO of Psigma discusses whether now is the time to take profits
Last week saw the latest round of quarterly market update presentations, where my team and I outlined three key messages that as valuations have risen risks have grown; of value in selective global equity markets; the fact that we believed that client expectations had to be managed down after five healthy years for asset markets.
The response to these sensitive topics from our audience was decidedly mixed, so today I will attempt to explain our thinking further.
It is our view that after one of the most powerful equity bull markets in the history of man, investors need to be aware that the ripe, low-hanging fruit have all been picked. Making returns from equity markets going forward will be much more difficult. Moreover, we believe that following the herd in to relatively expensive US and UK equities is not the key to making healthy returns in the years ahead. Instead the value markets in North Asia – including Japan, Peripheral Europe and certain Emerging Markets such as Brazil are where investors should be strategically asset allocating.
The sensible response from the table was whether by seeking out returns in such contrarian destinations we were radically shifting higher the risk profile of our client portfolios? This is obviously not an easy question to answer, as it entirely depends on your definition of risk.
Our response was that we actually viewed reducing more expensive parts of the world for cheaper investments as tantamount to de-risking, believing that the two primary investment risks are losing money and opportunity cost. To us, selling expensive US equities on 16 times earnings and buying moderately-priced Japanese stocks on 11 times is a de-risking trade. If one defines risk as volatility, as our industry obsesses over, then there is certainly a case to be made that we have upped risk over the last year; Japanese, European and Asian markets have been much more turbulent than their American and British peers.
However, our investment process is centred on the fact that the past is the past, not the prologue, and as we gaze in to the admittedly foggy horizon, our conviction remains that a combination of economic-sensitivity and lowly valuation should be the key to generating returns in a world of divergent ratings, polarised sentiment and gently improving growth.
It was in the questions after that the heat was cranked up on the presentation team, as we were interrogated about what those future returns might be. I suggested that if someone were to offer that balanced portfolios would deliver a return of 5% per annum after charges for the next five years then we would take it now. After annualised double digit returns over the last five years, we feel it is right to be realistic. With interest rates effectively zero and likely to be low for some time to come, inflation subdued, bond yields extremely low, corporate credit eye-wateringly expensive and there being no immediate upwards pressure on commodity prices, it would be difficult to forecast rampant returns in the coming years.
Moreover, with many equity markets close to fair value and needing significant corporate earnings power to justify their ratings, a healthy dollop of reality is appropriate. We believe that equity markets, especially the aforementioned contrarian trades, will make headway in the coming years, but the next five years will not be as strong as the last few years. Increasing equity allocations now would undoubtedly be a shift higher in risk profile, as valuations are generally much more expensive.
With clients sensing the world is improving around them, the press full of stories of economic joy and IPOs / M&A lighting the fires of exuberance, the biggest risk is that investors’ aspirations run ahead of potential.
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