A quick review of the past 12 months has seen a plethora of developments. To name a few, we have navigated a strong commodity rebound, high-profile impeachments, unlikely election victories and the end of an earnings recession. We have also witnessed the continuation of the low inflation and low interest rate environment, although these are thought to be changing as part of the Donald Trump induced reflation story.
The importance of asset allocation must be acknowledged in this regard, especially as valuation pressures mount in key markets – particularly US equities and European treasuries. Equity exposure has generally proved beneficial to end-investors, with a 23% global rally in US dollar terms, while headline fixed income has been relatively flat at 0.6%. Therefore, higher risk profiles have typically outperformed those with a cautious stance and elevated cash.
As we monitor the leaderboard, the standout asset class exposures over the past 12 months to February 28 are as follows
Emerging market exposure – equities up 31.2% and local emerging market debt up 15.7%. Russian and Latin American equities a standout, up 45.4% and 48.1% respectively. Brazil is up an astonishing 96.9%.
Sector-focused exposure – banking, materials, technology and energy are all up 41.3%, 37.4%, 32.3%, and 27.9% respectively.
Lower-grade debt – global high yield debt up 18.8%. For context, European aggregate was down 1.8% over the year.
Offshore currency exposure – British pound notably weak against the US dollar, down 10.7%. Euro more stable, although still down 2.2% against the US dollar.
The central idea is to appreciate the historical development, but avoid the extrapolation of these trends. The key is to focus on the fundamental drivers of returns and acknowledge that a further 20% plus jump is unlikely to be repeated if the fair value has not materially shifted.
This requires investors to carefully manage downside risk and focus on targeted opportunities. While the economic data is strong and sentiment rides high, cash can act as a drag on relative performance. However, it should not be ignored as it balances the risk and return characteristics of the portfolio and can be deployed if valuable opportunities present themselves.
“The biggest mistake investors make is to believe that what happened in the recent past is likely to persist”: Ray Dalio.
