Anticipating an uptick in volatility, Edward Smith, global strategist at Canaccord Genuity Wealth Management, has reduced his equity allocation by 7%, rotating into cash, currency plays and bonds.
‘Our forward looking measure of portfolio risk increased, so we’ve sold down positions in property, oil and European equities accordingly,’ he said.
In the firm’s balanced portfolio, Smith has recycled some of these proceeds into a new position in a long US/short Canadian dollar exchange traded fund (ETF).
‘As profitable investment opportunities in commodities have dried up, we believe money will start flowing out of Canada and back into the US.
‘The Canadian private sector is dangerously over-indebted and our fair value model suggests the US dollar could appreciate by more than 10% against the Canadian, irrespective of the general direction of equity markets,’ he added.
The remainder of the proceeds went into cash, and the Ignis Absolute Return Government Bond fund.
‘So has the whole City’s. The fund’s £1 billion inflows are a slight concern in terms of capacity,’ Smith said, ‘but it doesn’t bother me too much.’
Late last year, he bought an iShares ETF for European equity exposure after the BlackRock Dynamic Europe hard-closed in autumn. He also upped the portfolio’s allocation to US large cap and UK ETFs as ‘a tactical play’.
Over the last year, he has doubled his exposure to the US to 20%. The portfolio holds the Vanguard US Opportunities fund to get exposure to small and mid caps, alongside a S&P 500 tracker.
In fixed income, Smith sold out of his 6% government bond exposure and reduced the portfolio’s corporate bond allocation by 6% over the last year. He still believes bonds have a place in multi-asset portfolios, despite ‘no more than low single digit’ return expectations.
Over the last 12 months, the portfolio has returned 5.9% versus the WMA Balanced benchmark, which rose by 7.2% over the same period.
Since the model was launched in 2011, it is up 19.8%, versus the benchmark, which is up 22.2%.
‘We have also exposed our clients to considerably less risk and, as such, our Sharpe ratio stands considerably higher at 1.03 versus 0.75 for the WMA Balanced,’ he said. The portfolio has averaged 5.7% volatility since inception, considerably less than the WMA’s 10%, he added.
Over 12 months, volatility was 6.5% compared to 8.5% for the benchmark.
Smith admits he held gilts for ‘slightly too long’, which dampened performance. ‘We were certain [Bank of England governor Mark] Carney would introduce forward guidance properly, but he ended up by introducing a forward guidance laden with inflation caveats, so of course gilt yields carried on rising,’ he said.
Conversely, performance was driven by US Vanguard Opportunities, iShares FTSE, infrastructure plays and a 5.8% position in the ‘stunning’ Polar Capital Healthcare fund.
Smith believes markets will continue to move sideways through the first half of the year. After the strong period of multiple expansion driven by quantitative easing (QE), he warned that equity markets could start struggling as QE is reduced further.
‘This could shave off 2% a quarter.’
The investment manager anticipates that stock markets will still return between 5% and 8%, with the US at the top end of the range, followed by the UK, and Europe towards the lower end of the spectrum.
He also expects emerging markets to pick up after performing poorly in the first half.
BUY: Short Canadian dollar, long US dollar ETF
The challenge for asset allocators in 2014 is to identify investments that have a low correlation with both bonds and equities – investments that will diversify portfolio risk in all market conditions while also providing a return. To that end we have purchased this currency position via an ETF. As profitable investment opportunities in commodities have dried up, we believe money will start flowing out of Canada and back into the US, where economic growth will come closer to the pre-crisis average than in any other developed market economy. The Canadian private sector is dangerously over-indebted and our fair value model suggests the USD could appreciate by >10% against the CAD, irrespective of the general direction of equity markets.
HOLD: Vanguard US Opportunities fund
A great fund that has recently soft closed. The US is one of the few economic regions in which growth is likely to approach the pre-crisis trend this year. Now that the QE-driven era of multi-expansion is more or less over, investors need to look for earnings growth to drive returns. This fund favours mid and small cap stocks that we believe are better exposed to some of the acyclical themes driving US markets (the fracking revolution, for example)
SELL: Emerging Markets
A range of conflagrant macroeconomic problems are plaguing a broad cross-section of emerging market countries. Over-indebtedness is a rampant problem throughout the developing world. By our calculation, private non-financial borrowing has almost quintupled since mid-2005 and totals 127% of GDP. As governments look to curtail further credit growth and foreign lenders are less willing to extend new loans to the region, economic growth is very likely to shrink further. Moreover, our favoured valuation measure (trimmed mean PE ratio) suggests that they are not even cheap.