Half of all wealth managers had moved to either explicitly or implicitly hedge their equity exposure at the beginning of Q2, as the macroeconomic uncertainties of the last five years began to give way to more tangible concerns about equity valuations, earnings and momentum.
Polled as the tech sector led US indices downward over the first half of April, exactly 50% of correspondents to Wealth Manager’s quarterly survey said they had upped cash, increased absolute return allocations, or directly bought derivative or volatility protection.
Much of the remainder either reported running down equity allocations or reorientating exposure toward lower-beta areas of the equity markets.
Short-term prudence had not yet spilled over into real risk aversion, however. Asked to describe the level of equity risk they were currently running in client portfolios, on a scale of one to 10 where 10 was the greatest, the median response was 6.24.
‘We’ve seen a complete change in the nature of investment risk over a very short time,’ said Alastair George of Hasley Investment Management.
‘Not so long ago, markets were obsessed with economic volatility while low valuations were overlooked. Now, economic risk is much lower but the key risk is in equity valuations, especially for mid caps as US and UK monetary policy normalises, even if only slowly.
‘Our equity portfolios are weighted to large caps where valuations are still reasonable. There’s rather more evidence of over-enthusiasm in the mid cap sector. [We are not actively hedged], we’re just keeping it modest.’
Buying covered calls
Gary Stockdale, principal of Vertem Asset Management, said he had bought covered calls and upped absolute return exposure, while Courtiers chief investment officer Gary Reynolds said he had cut equity beta and purchased put options. Heather Maizels, managing director of Victoria Private Investment Office, has hedged volatility.
‘We have recently added an asset allocation towards absolute return to give us some insurance policy towards future volatility in the equity markets,’ said Peter Lowman, chief investment officer at Investment Quorum. Popular picks included Troy’s Trojan fund and the Darwin Multi Asset fund.
While managers where taking prudent steps to limit potential downside, the more targeted and nuanced nature of their risk aversion was obvious from their overall market exposure, with net allocations to equity actually rising slightly over the period.
On aggregate, across the five major geographical regions of the US, UK, Europe, Japan and developing, the number of managers reporting underweight equity exposure rose from 15.54% to 17.76%.
That remained toward the lower end of the scale over the full three-year span of the survey however, well short of a high of 47.94% in Q4 2011 and below the three-year average of 22.95%.
It was also accompanied by a parallel increase in the number of managers running overweight allocations, which rose from 48.14% to 51.44%. Those two polarised moves were funded by a squeeze on neutral equity allocations, which slid from 36.26% of managers to 31.44%.
Equity scepticism certainly did not prompt a dash back into fixed income either. This, for the first time in the history of the survey, recorded zero managers overweight across all four classifications, developed sovereigns and corporates and emerging market general and local currency.
‘Sit tight’ strategy
At the geographical level of equity selection, managers largely continued the ‘sit tight’ strategy which has characterised the last six months, only incrementally moving at the margins.
The two big substantive moves over the first quarter was for neutral weightings in emerging markets to flow into overweight, which near doubled from 22.2% of respondents to 42.9% over the period, and taking profits on Japanese allocations, with overweights falling from 63% to 42.9%.
European overweight allocations ticked back up from 63% to 74%, while investors also returned to US equity overweights, which rose from 44.4% to 50%. After a brief outbreak of nerves at the end of last year, no managers were willing to risk underweight allocations in either the UK or Europe.
Both Stockdale and Charles Stanley’s Birmingham boss Richard Venner listed when and how to take emerging market equity exposure as the single biggest decision investors would face over the next 12 months.
‘I would expect to see emerging markets and large cap equities continue to make acceptable but not extraordinary progress, based on current valuations and the economic outlook,’ added Hasley’s George.
‘After five years of coordinated emergency efforts by global authorities, economies are still reliant on low interest rates and high debt to maintain growth and confidence,’ said Daniel Lockyer of Hawksmoor.
‘We are now entering a normalisation phase where a more discerning approach is required so not all asset classes can keep on producing positive returns.’
Beyond short-term market valuation concerns managers were pretty sanguine about the state of the world. Over a 12-month timeframe, 86.7% predicted that global growth would rise versus 13.3% who thought it would change little, from 82.8% and 17.2% respectively three months ago.