Top global assets for your portfolio
Being in the right place at the right time is as important in investment as it is in life. Investors, though, can perform a neat trick: they can diversify and be in several places at once – always a good idea in difficult times.
Although financial markets have recovered strongly around the world, largely in relief that the recession did not turn into a full-blown depression, the way ahead looks full of potholes for the unwary.
In the fast changing economic environment we are currently in it is important to review your asset allocation regularly. We consulted a panel of five asset managers who think globally and strategically about investment and asked them to take a view of up to 10 different investment sectors.
The results show continuing support for UK and US equities, but less enthusiasm for emerging market equities. There is a lot of positive noise around commodities and reviving interest in the property sector.
Corporate bonds are still in favour, although largely on yield considerations rather than the prospect of further big capital gains.
However, not one of the panellists has a good word to say about UK government bonds (gilts), and there is precious little enthusiasm for other forms of sovereign debt.
"I cannot make any case for gilts at all," says Dean Cheeseman, head of fund of funds at fund management firm F&C. "I don't like them," says Robert Talbut, chief investment officer at Royal London Asset Management.
"I would not touch them," declares Jan Luthman, a fund manager at asset manager and stockbroker Walker Crips.
Cheeseman adds: "Government bond markets, particularly in the UK and the US, have been massively supported by the central banks and this will continue for the foreseeable future.
Ultimately, though, this is going to put upward pressure on yields, which we can expect to rise later this year."
Schroders chief economist Keith Wade is "concerned about a bit of sovereign risk coming into play."
He fears a further downward lurch in the value of the pound and a downgrading of the UK's AAA credit rating.
Only Michael Turner, head of global strategy and asset allocation at Aberdeen Asset Management, makes a positive case and that is solely confined to the government bonds of some emerging markets.
"Emerging market debt still has big attractions, particularly denominated in hard currencies such as the dollar," he says. "But local currency emerging market bonds are going to be more attractive going forward.
Although interest rates in some of these markets are now going up, that is leading to an improvement in creditworthiness in some emerging countries. Also, these local currencies are likely to appreciate over time, particularly against the dollar."
Bull or bear?
Some of our panellists are more cautious than others about the overall prospects for financial markets. Talbut is in the cautious camp. "We have escaped from a near-death experience: a potential depression in 2009," he says.
"And just as I would say it has not been a normal recession, so I don't think it is going to be a normal recovery. This is the key point of difference between myself and those who are more optimistic."
"I don't foresee a normal recovery: it is going to be more stuttering, more uncertain and prone to shocks. I don't want to be fully exposed to markets."
There is still considerable enthusiasm among the panellists for equity markets. Markets have come up a long way since the dark winter of 2008-09.
Wade has an upbeat message: "We are positive overall on global equities. GDP growth is always helpful, but the real argument for us is that we can see corporate profits improving.
"Against a background of low interest rates and improving profits, we think equity valuations still look quite reasonable."
Wade highlights US equities, but also Japan. "We are not always positive on Japan, but we are at the moment," he says.
"It is partly a catch-up story because it lagged other countries last year, but there is a new finance minister and a new administration who seem to recognise the need to stimulate the economy more and to try to weaken the yen."
Cheeseman shares Wade's interest in the Japanese market: "Japan could be the dark horse in the race: it is a beneficiary of China's growth and the government is saying the yen is too strong. In Japan, when the yen goes down the stock market usually goes up."
Turner watches two key indicators: levels of liquidity in the financial system and the willingness of investors to take on risk.
"Liquidity is more abundant than ever, given the amount of money that has been pumped into the global financial system, and this tends to support the price of riskier financial assets," he says.
"Interest rates are likely to remain low, and when they are low the return on non-risky assets is likely to remain unrewarding."
Because of this, Turner takes the view that the yield on riskier assets such as equities, property and corporate bonds is going to become more important.
"Ultimately, yield and the prospect of yield growth is what you should focus on when deciding what is an attractive asset," he says. "Cash flow is the engine room of financial markets and ultimately what determines growth."
He thinks UK equities are slightly undervalued, based on the prospect of 15-25% growth in corporate profits over the present calendar year.
Turner remains keen on emerging markets. He says: "Strategically, we think growth in emerging markets is going to be materially higher than it is in the developed world."
Although he sees monetary policy tightening and interest rates rising in countries such as India, Brazil and China, he says "we don't think this will necessarily derail the performance of those equity markets".
Recovery or double dip?
Cheeseman stresses that F&C is in the "economic recovery/growth camp rather than the double-dip recession camp", although he admits that the key triggers he looks at, such as the unemployment figures in the US, are sending out "mixed messages at the moment".
Like Talbut, he thinks the recovery will not be straightforward. "We have seen an incredibly healthy run in the markets, but from now on we can expect to see two steps forward and one step back," he says.
"November brought us Dubai, February brought us Greece, and now the credit-rating agencies are rattling Portugal's cage."
He believes it is vital that the UK government communicates what he calls "the exit strategy from the present emergency climate" in coming months.
Cheeseman believes inflation and rising interest rates will become a problem in 2011. "How that is handled is going to be pivotal to market sentiment," he says.
Even so, he feels there are enough supports for the UK equity market. "The UK share market is geared towards oil and banking," he says.
"In oils, we have a supportive oil price and in the banking sector the worst seems to be over, while HSBC and Standard Chartered are two powerhouses of the Asian economy."
Cheeseman is less keen on equities in the eurozone, which he gives just a four rating. "Members of the eurozone are learning the hard way that one size does not necessarily fit all."
Luthman's strategic approach is much more straightforward. He sees UK markets as an excellent proxy for global investing. "What we look for is global companies quoted in London that have a significant proportion of, or all, their earnings outside the UK," he says.
"There is greater opacity when looking at stocks outside the UK, particularly in emerging markets. Here, you have the benefits of governance in the UK, UK accounting standards, and you have a valuation in UK currency."
He anticipates significant headwinds for the UK economy for some time to come, seeing sterling as "fundamentally weak".
"The point of gaining exposure to non-sterling earnings through UK companies is that the value of those earnings rise as sterling weakens," he points out.
Looking at global credit, which covers investment-grade and high-yield corporate bonds, there is some enthusiasm among panellists after the strong performance of this asset class in the past year.
Cheeseman thinks the investment-grade corporate bond market remains attractive, but "you are now playing it for yield".
He prefers the high-yield sector, which he gives a score of eight. "This remains our favoured sector, provided you have a proven investment manager for the fund you are buying," he says.
Turner sees corporate bonds as a useful way of spreading risk. "If your individual risk profile is lower, we suggest having more exposure to corporate bonds than to equities," he says.
"At present, investment-grade bonds, like equities, are not on a particularly demanding valuation, nor are they particularly cheap."
Both Wade and Talbut see positive signals on corporate bonds. "The world is hungry for yield, and corporate bonds can still offer good yields,' says Talbut. "We still think they are attractive relative to government bonds."
Commodities provide another intriguing area for discussion by the panellists. Talbut highlights the merits of soft commodities in a world where climate change is the big issue.
Cheeseman agrees: "Extreme weather is messing up crop harvests and that plays well with the soft commodities markets.
"The credit crunch also meant that some farmers around the world could not afford to use fertilisers, so yields went down and prices went up."
The panellists have mixed feelings about metals markets and showed some ambivalence about the gold price.
"Gold is caught between two trends," says Cheeseman. "One trend is going back to the use of gold as a currency. This is almost your bear case: the currency of last resort.
"But the bulls will make a case out of the expansion of Asian demand. It is one asset class that appeals to both ends of the investment risk spectrum. But as soon as the bulls or the bears win, the other side is going to dump it."
Luthman, though, argues that the creation of new money through quantitative easing is "what lies behind the continued rise in the price of gold".
He says: "We hear that gold has no intrinsic value. That argument entirely misses the point that money itself has no intrinsic value.
Quantitative easing is the ultimate faith-based currency. This is new, imaginary money created by the Bank of England at the touch of a button."
Turner also remains a gold bull. "I expect the price of gold to reach $1,300 an ounce in the next year," he says.
This article was originally published in Money Observer - Moneywise's sister publication - in May 2010
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Corporate bonds are one of the main ways companies can raise money (the other is by issuing shares) by borrowing from the markets at a fixed rate of interest (the reason why they are also known as “fixed-interest securities”), which is called the “coupon”, paid twice yearly. But the nominal value of the bond – usually £100 – can fluctuate depending on the fortunes of the company and also the economy. However it will repay the original amount on maturity.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).