Brooks Macdonald, the AIM listed investment management group (£11.7bn funds under management) has announced its asset allocation review for July 2018.
Edward Park, investment director at Brooks Macdonald, explained Brooks Macdonald’s asset allocation changes following July’s Committee meeting.
In the first half of the year the company seen a divergence in growth appear between the US and the rest of the world. Recent economic data suggests that this should continue for the time being with Asia and the Eurozone looking like they are driving the slowdown in momentum. The current strength of the US economy has allowed markets to largely shrug off the softer global data.
As they entered the Q1 earnings season, growth expectations were revised up due to the effect of US tax reform but the Q2 upgrades are based on more fundamental factors. This is only the second time in 7 years that Brooks have seen two consecutive quarters of consensus earnings upgrades suggesting that corporate America is in good health. That said the risks to the global growth story are becoming more pronounced in our view, whether this is the US/China/EU trade dispute, political risk in Europe or leverage ratios in US companies. Given this they remain sellers on rallies rather than buyers on dips.
China remains key and the recent slowdown in some metrics such as retail sales suggest that momentum is unlikely to reverse in the shorter term. China is a larger trading partner than the US for 70% of countries around the world and this weakness is already feeding through to these other nations. The recent cut in the reserve requirements for banks do show that the People’s Bank of China is willing to react to support the economy via monetary policy however. The US dollar has been strengthening versus several major currency pairs so far in 2018 and this is due to a combination of stronger US growth, higher US interest rate expectations and tightening US dollar liquidity.
Investors were largely positioned for a weaker dollar as we started the year and the reversal of this sentiment helped the rapid appreciation of the currency in Q2. These factors are unlikely to lessen in the short term and this will continue to put pressure on emerging markets who rely on US dollar funding lines to finance their external debt. Longer term we expect the dollar to weaken due to structural current account deficits and the currency looking expensive on a purchasing power parity basis.
Around the time of the EU referendum we cut our exposure to UK property given concerns over the health of UK corporates but also us moving away from open ended property funds given the liquidity mismatch between daily traded funds and an illiquid underlying asset. In the place of this we invested in closed ended REITs, particularly in the specialist areas such as logistics warehousing, social housing and healthcare. Many closed ended property funds have structural gearing within their funds which they use to meet their yield targets and at the same time many of these funds are trading on a premium to their net asset value.
Reits have a volatility profile more akin to equities than bonds and as a result we have decided that as we enter the latter part of the cycle we should reduce our property exposure as we seek to reduce the overall equity sensitivity of portfolios. Given this we have reduced all risk profiles to a 2% weighting to the asset class (bar High risk which has a 0% weighting).
They continue to have concerns over US High Yield credit and have been moving some of this exposure towards UK short dated gilts over the last few quarters. Should Brooks Macdonald see a US led recession in late 2019/early 2020, which is the consensus view, credit spreads are likely to widen.
In this scenario investment grade and high yield debt are unlikely to provide much downside protection, which when paired with the capped upside inherent in bonds, means corporate debt offers asymmetric returns in their view. This is particularly true with interest rates as low as they still are which leaves less room for rate cutting by central banks and therefore less room for capital gains from bond duration.