Tristan Hanson at Ashburton rates valuation, liquidity as key factors
Tristan Hanson, head of asset allocation at Ashburton, suggests that valuation triggers and liquidity should be priorities for asset allocators in the current environment.
The third quarter has proven to be a challenging period for all investors, asset allocators included.
Volatility has risen abruptly, safe-haven assets, such as government bonds, offer poor value, and widely favoured structural trades (emerging market currencies, for example) have come under severe pressure.
US government bonds have been an unexpected winner, despite the debt ceiling fiasco and subsequent S&P rating downgrade.
Despite being the epicentre of current fears, the euro has remained remarkably resilient against a number of currencies with better ‘fundamentals’ such as the Norwegian kroner, Australian dollar or Korean won. Policy risk has also been at the forefront, EU announcements and the SNB intervention being clear examples.
Where, then, is an asset allocator to find value? And how can risk be managed? Risky assets such as equities or US high-yield corporate bonds have, in general, reached levels that are likely to provide attractive medium-term returns.
Similarly, the violent sell-off in a number of EM currencies does not look much like a considered reassessment of fundamental value.
Adding exposure across these areas is likely to yield positive returns over time.
While most recognise equity valuations are inexpensive, few are willing to enter the market, reflecting depressed sentiment and fear over the European sovereign crisis.
Those who find value in risky assets but worry about a European policy error may want to own protection through a variety of ways: the dollar and German or French sovereign CDS might be plausible candidates.
So might US treasuries or gold, although the former offer generally poor value and the latter has behaved like a risk asset.
UK inflation-linked gilts arguably offer reasonable value at current yields, given RPI inflation expectations and the prospect for additional QE in the UK, should conditions deteriorate.
Much of the focus in financial markets is wasted on unpredictable short-term noise. In the medium-term, however, trends in fundamental factors determine investment returns.
Clearly, when policy risk most acute, determining the likely path of fundamentals is most challenging.
Under such circumstances, we believe valuation triggers should be given a high importance.
Sources of cheap insurance sought out, diversification emphasised and liquidity prioritised.
For these reasons, we favour global equities and US high yield corporate bonds; North American and Asian currencies over European currencies; a variety of relative value trades within fixed income markets and positions in UK index-linked gilts.
Tristan Hanson is head of asset allocation at Ashburton