Tcam's joint chief executive and CIO talks encouraging fundamentals and making Europe attractive.
It has been a fashionable 12 months for geo-politics. From ‘Brexit’ to ‘Frexit’ and ‘IndyRef’ to ‘Trumpnomics’, the terminology has become part of the everyday lexicon, spurring a wealth of headlines more arresting than news of improving PMIs.
Against this backdrop, our recent asset allocation meetings have been decidedly unfashionable, with discussion focusing on the trajectory of fundamental data as opposed to any probabilities of a Trump impeachment. Of course, that is not to say that politics are not important – short-term style shifts driven by last year’s events created a very tricky environment for many active managers.
However, it is improvements in data points such as wage growth and risks such as duration and inflation that are driving our longer-term asset allocation decisions.
Encouraging fundamentals are a key reason why we like Europe at present. It was feared that Trump’s victory would herald a new dawn for populism in the region, particularly with the major economic players heading to the polls during the succeeding 12 months.
However, Marine Le Pen’s defeat in France and a boost for chancellor Angela Merkel in North Rhine-Westphalia dictate that the European story is now centred around the data, rather than any further break-up of the Union.
Unlike the UK, latest GDP figures impressed, while unemployment continues its progress towards non-accelerating inflation rate of unemployment. Underemployment – a key factor for wage growth – is also retreating from 2015 highs. In combination, the figures make it increasingly difficult for Mario Draghi to insist the European Central Bank maintain its ultra-accommodative monetary policy.
Accordingly, our exposures focus on those areas that are best placed to benefit from any increase in interest rates, as well as improving data. Financials in particular offer attractive valuations.
We won’t find out until 8 June whether Draghi has begun to change his stance on policy normalisation, but whether rate hikes should come sooner or later, duration is a key risk at present. With tightening continuing in the US, we have minimised exposure to long duration equities and remain particularly cautious on the bond market.
In a lower-growth world, where the thirst for income has seen yields bid to near-historic lows, the effects of sustained policy normalisation are potentially severe. Fed chair Janet Yellen may be more measured than former Fed chair Alan Greenspan (a string of rate increases during the latter’s tenure shocked the bond market in 1993/94), but her cautious approach could ultimately prove her undoing if the data confirms the Fed is behind the curve.
We have moved away from conventional and index-linked bonds in favour of other areas of the market that look more attractive, including European financial debt and direct securitised lending.
As fundamentals return to focus, we also consider alternatives to be a key asset allocation call. While style shifts driven by the macro events of 2016 created a tricky environment for many of these managers, we believe the asset class remains attractive in the longer term.
Investments in many geographies and sectors look expensive and hence, portfolio diversifiers such as long/short equity and derivative structures provide useful protection against a pick-up in volatility.
If you would like to share your asset allocation insights in the next Investment Committee panel, email Suzie on firstname.lastname@example.org