Citywire printed articles sponsored by:
View the rest of this gallery online at http://citywire.co.uk/wealth-manager/gallery/a699854
How 10 wealth managers plan to play Fed tapering
by Elsa Buchanan on Sep 02, 2013 at 13:57
Within months Ben Bernanke's Federal Reserve could begin slowly turning off the QE tap. Here, 10 wealth managers share their strategies for when tapering hits.
Nick Hungerford, Nutmeg chief executive officer
Like many market commentators, Hungerford believes the Fed will combine tapering with a reinforced commitment to keep rates unchanged until the recovery has stuck.
Against this backdrop, Hungerford told Wealth Manager that emerging market equities are unlikely to wave goodbye to their current difficulties. A number of markets have been hit by the high oil price, and the fears surrounding this, and although cheap, the chief executive said slowing growth will continue to cause problems for emerging market stocks.He explained: ‘Despite emerging markets looking particularly cheap on a valuation basis, slowing growth across the major developing economies and high sensitivity to rising yields means we continue to expect them to underperform developed markets.
‘In developed markets, we favour European and Japanese stocks. European stocks offer the potential for good returns over the next year given [their] low valuations and the improved prospects for growth in the region.’
What’s more, while the Fed has been planning to turn off the easing tap, the Bank of Japan (BoJ) looks set to lift the crown of the most aggressive central bank globally as it doubles the size of its monetary base over the next two years.
But Hungerford said the BoJ will have to do more to meet its 2% inflation target, though he argued the reflation effort is a plus for equities, and with the UK and US growth prospects picking up, this has reassured Nutmeg over its cautious approach to bonds.Moreover, he explained that even though last week had seen equities come down on the back of concerns about Syria, the sell-off endured by developed markets should peter out.‘We expect the developed market selloff to proceed at a far more measured pace over the remainder of the year and favour holding company instead of government bonds and only those with a short time to maturity. For physical assets we continue to expect a reduction in demand as the emerging markets, and particularly China, shift away from investment-led growth,’ Hungerford said.
Michael Lally, director of Thesis AM
Thesis' Lally hinted it could be time for investors to take shelter when tapering eventually hit.
When asked how he would play it he said: 'Steel helmets and waterproof underwear' seemed like a good starting point.
Jonathan Clatworthy, senior investment manager, Arbuthnot Latham
’The prospect of Fed tapering has been very well publicised, to the point where even high street book makers in the UK are now taking bets on when this will happen. This level of scrutiny has seen longer term rates move quite significantly, [versus] relatively muted movement at the front and “belly” of the curve,’ Clatworthy noted.
He added non-parallel shifts in the yield curve could be a big risk for investors a trying to protect capital by positioning in short to mid-term maturity bonds.
Clatworthy said that with a normalisation of rates due in the medium term, equities continued to offer the best risk-adjusted returns, though he acknowledged Arbuthnot had increased its allocation to market neutral strategies to help protect against volatility.
Away from the US, Clatworthy agreed with emerging market bears that developing nation prospects would likely remain weak.
‘We expect to continue to see a subdued performance from larger EM economies dependent on international fund flows until the monetary policy position in the US has some clarity. Following this, we expect there to be a good entry point for longer term equity investors following the sharp falls seen recently, due to the discounted valuations when compared to the developed markets.’
Johan Jooste, Julius Baer, head of London investment office
Jooste said investors should remember that while there has been a lot of talk about tapering, the process will run on for some time.
Currently, he added that equities are ‘notably more attractive’ than bonds, and pointed out emerging market debt had already reacted to taper chatter and fallen in value.
’Even after the recent correction, emerging market debt remains one to avoid,’ Jooste continued. ‘Even in the developed world, as interest rates start to tick up, longer maturity bonds will be become even less alluring than they are today.’
He added: ‘We believe there is still upside, on relative basis, in corporate bonds (as economies get stronger the risk of default eases) and in equities. [We] choose developed market equities over emerging equities and seek out growth rather than defensives – industrials for example. Real estate is under loved and worth tucking away for those who are looking for income.
’In currencies we believe investors should curb their enthusiasm for the dollar. If, as economies begin to recover, risk assets start to look more attractive; then safe haven US treasuries will be less in demand.
Peter Lowman, chief investment officer, Investment Quorum
Lowman would not be surprised if the Federal Reserve held off on tapering until December, because there are so many other factors at play and these present a risk to the US recovery.
Among the threats are the recent drop in home sales, but also unemployment figures, the budget deficit and reservations surrounding future US corporate earnings, Lowman said, though there are also the geo-political ones linked to the Middle East, and the strengthening US dollar.
[These] have already created further uncertainties over the past few weeks, adding to what is already a difficult period for investors and riskier asset classes,’ the CIO explained.
He added: ‘Nonetheless, in terms of our investment strategy we still favour global equities over government bonds, which undoubtedly will suffer once US tapering begins in earnest. In terms of asset allocation we prefer the developed markets over developing, with the UK, Europe, and Japan being favoured most given their recent better-than-expected economic data and fundamentals.
’Alternatively, we do like high yielding bonds, UK commercial property and REITS, as a proxy for sovereign debt, given their attractive yields, potential for further capital growth, and a view that interest rates will remain lower for longer.
David Joory, Bedrock's chief investment officer
Joory said: ‘At Bedrock, we believe the end of QE3 is near and that the Fed’s accommodative policy will be unwound over the course of 2014. While the Fed has been attempting to calm the markets by emphasizing that there will be stages to the unwinding and that such action is different from an actual increase in policy rates, if growth continues at a modest level and employment improves, the Fed will eventually raise rates. As such, we [think] there is an elevated risk of higher rates in the near to mid future.
Taking all this into account, Joory said that since the beginning of 2013 his firm has been gradually reducing exposure to fixed income and repositioned within the asset class towards sub-sectors or investment strategies with lower duration risk, such as short-term corporate bonds, senior secured loans and unconstrained bond fund strategies which can actively manage their duration exposure.
Joory said their hedge fund exposure had also been bumped up as fixed income was trimmed back.
‘We have modestly increased our hedge fund allocation [by] favouring global macro managers, as we believe these will be able to benefit from the many macro trading opportunities that are being created as different economies find themselves at different stages in their business cycles,’ he explained.
Christopher Sexton, chief investment officer, Saunderson House
Sexton has put the bulk of the recent market volatility down the Fed’s tapering plans and has been keeping a close eye on treasury yields since Ben Bernanke told investors of his intention to slowly wind down easing.
He said: ‘In our view, a good deal of the current market volatility is related to the prospect of the Fed tapering its asset purchase programme. However, investors should bear in mind that the yield on the 10-year US Treasury bond has already risen from around 2% on 22 May - when Fed chairman Ben Bernanke first mentioned the potential winding down of QE - to more than 2.75%.
He continued: ‘This represents a reasonably substantial tightening of monetary policy. This suggests to us that when tapering actually begins the impact may have already been priced into bond and equity markets. The other factor to be borne in mind is that the Federal Reserve has gone out of its way to make clear that the 'tapering' of QE is data dependent. In other words, if the US economy does not show continued signs of improvement, tapering will be delayed. In short, markets will have either a strengthening economic picture, or further policy support - but not both.’
Gregor Macintosh, Lead manager, Lombard Odier Total Return Bond fund
Macintosh told Wealth Manager that In the current environment, he and his team preferred an absolute return approach to bond investing, believing that the traditional buy and hold approach does not offer enough flexibility to exploit short-term mispricing.
‘We believe the absolute return approach is more likely to deliver better returns within acceptable risk limits as central banks withdraw from QE. We use techniques like interest rate futures, floating rate notes and credit default swaps to alter a bond portfolio’s interest rate and credit sensitivity and thereby give investors a positive return uncorrelated to the wider market and direction of interest rates.‘Right now we are avoiding long duration bonds, particularly the US, the UK and German treasuries. In a rising interest rate environment we are exposed to the dollar. As the US economy recovers further, we believe that the dollar will benefit.
Alan Higgins, UK chief investment officer, Coutts
Higgins said Coutts was overweight equities and underweight bonds before the debate over when and how much the Fed should taper QE, but added the private bank is not convinced economic data supports tapering in September.
’Although contrary to our view, it looks increasingly likely the Fed will act,’ Higgins said. ‘This shouldn’t prove destructive for markets provided the Fed holds to its assurances that any withdrawal will be in line with economic recovery. Tapering would have to be accompanied by sustainable growth, which would be positive for equities.
He added: ‘Conversely, the higher interest rates likely to follow improved growth should see bonds fall further, reinforcing our underweight stance. We have rebalanced fixed-income exposure away from government bonds in favour of corporate bonds less sensitive to interest rate changes and which offer higher yields.
’Less liquid markets such as emerging-market equities and commodities are also likely to weaken when liquidity is withdrawn. We have reduced our exposure but still hold some gold as a hedge against inflation and other risks like the fallout in emerging currencies and rising Middle East tensions.
’Despite its positive message on growth, the removal of stimulus will heighten market volatility. To protect against this, we have selectively trimmed our equity positions - although that doesn’t detract from our positive overall view on equities.’
Guy Foster, head of portfolio strategy at Brewin Dolphin
Foster said a lot of investors will look for defence against rising bond yields, and the best way to do this is to reduce fixed income exposure.
’Some, more esoteric, strategies may work well too,’ he continued. ‘Strategic funds, for example, may provide some protection but where they don’t explicitly have a cash benchmark they may be tempted to carry some duration. Many strategic funds may also have diversified into emerging markets which is an area we don’t currently favour. One fund we like is the Newton Global Dynamic Bond fund, which has an explicit absolute return mandate and we have good transparency in terms of positioning. We also buy the M&G Inflation Linked Corporate Bond fund which is benchmarked against the change in consumer prices.
‘These aren’t bond funds in the traditional sense. They would not, for example, be your first choice in a falling interest rate environment.
'The closest thing to a traditional bond market that still looks attractive is high yield. Spreads still look reasonable although strong flows, particularly now investors are rotating out of emerging markets, and high issuance are worth being wary of.'