Uncertainty creates differing views

Concerns about currency and financial stimuli along with general market uncertainty has led to disagreements between fund managers over their asset allocation. So, where should they invest?


Risk appetites have soared across the globe and equity funds have surged ahead. But no upswing continues uninterrupted and markets will retreat at some point, whether or not the upcoming data supports a rosier outlook. And whether they will only pause to take a breath before avoiding a resumption of the bear market is yet to be seen.

The rush to sanctuary in bonds has abated with the equity bounce, but bonds arguably remain at lofty levels relative to the gargantuan pressures being absorbed by governments’ fiscal positions for the longer term. This global equity market surge has pushed the MSCI World index ahead by 17.97% this year. The stars of the show have been the emerging markets, with MSCI Emerging Markets surging ahead 51.14% in 2009. The S&P 500 (12.99%), FTSE 100 (10.71%) and Dow Jones Euro Stoxx (15.78%) indices have had more modest runs in comparison. These smaller uptrends are substantial for developed markets, particularly trough to peak. The relatively dramatic returns of emerging markets reflect their status as a leveraged bet on global markets, nitro-boosting the up and down sides.

This dominance by emerging markets was respectably exploited by fund managers. The Investment Management Association (IMA) Global Growth sector reached a 12.15% return this year in sterling terms, versus a 35.51% return in the IMA Global Emerging Markets sector. IMA North America returned 7.76%, IMA UK All Companies returned 19.25%, and IMA Europe ex UK returned 10.26%.

The positions maintained by globally-investing fund managers have evolved over the year, and three points stand out in the accompanying chart. First, exposure to Japan was overtaken by other East Asian markets by the end of the first quarter. Book values that almost give some companies away are still not enough to remove the perpetual fear of another false dawn in Japan. Second, we can see that North American and British investments were the most volatile allocations in the typical IMA Global Growth fund. This is natural, with both countries being at the centre of the financial storm and mood swings in sentiment. Third, there is disagreement between global growth managers about the outlook for Britain, and thus what level of exposure is appropriate.

The chart illustrates “manager disagreement” over the allocation levels between regions within their funds. The manager disagreement ratio divides the variability of allocations across funds each month by the size of the typical allocation. Regardless of the size of the typical exposure to emerging markets, these countries suffer from the greatest disagreement between managers as to their allocation level. This is a necessary corollary of the fact that funds usually hold high levels of American or European securities, owing to their large contributions to global GDP and market capitalisation. Emerging markets have undoubted potential – as represented by their high and hopeful valuations – but they are small and future share is less certain. Opinions are therefore likely to differ.

While we know with reasonable certainty what contribution Britain makes to GDP and market capitalisation, it still sits high up the list of manager disagreement about its outlook.

Britain is one of those countries that has made much use of quantitative easing and other stimuli. Recent commentary show analysts are worried about how quickly stimulus will be withdrawn by governments. The mistakes from the 1930s have been well remembered, so premature withdrawal remains unlikely. Global concerns still circle the extent to which authorities have manned the printing presses versus the differing fiscal positions of states to back this up. The long-term flight to gold therefore remains intact and has edged up to hedge these global concerns. However, investors should consider currency risk as gold is priced in dollars.

Nevertheless, the international investor’s primary currency exposure is usually to the dollar, so the real choice for investors is whether or not a fund to hedge back all currencies to sterling.

“Gold bugs” might be disappointed if we do not meet some of the more stratospheric forecasts, but gold remains the market’s security blanket when there is suspicion of currency debasement or widespread economic weakness. It should continue to edge up in the medium term at least, although investors might consider not adding to positions during any scares that boost gold. The snap backs can be just as brutal.

Five years ago, pointing out the strange phenomenon of all asset classes rising at the same time often received a blank response. The unsustainable situation was that equities, debt, property and commodities were all rising in value. This broke fundamental macro inter-market relationships that drive us forward by defining the price and value of assets and money over the long term. As we have seen, this was not to last.

The current situation is not as preposterous, but we are not yet in a world of balance. These imbalances exist whether we look at them from fiscal, trade or financial flow perspectives. This surreal reality might have a shelf life, yet it could drag out so long that some may have to invest in this reality while it dominates.

Even the supposedly currency-concerned Chinese are still investing in the long end of the American yield curve. China is increasingly hungry for yield, with less concern for currency and capital risk than otherwise believed.

This will maintain imbalances and market “order”, and will ensure that long-term dollar interest rates remain lower than they would be otherwise. This Chinese search for yield is also throwing stimulus cash at Taiwanese investments, whose excited market might build in longer-term valuation risks.

The economic evidence for recent enthusiasm was thin on the ground. Although it is solidifying for the near-term, longer-term growth prospects will go through a period of adjustment. Equity markets will speculate on their opinions and sovereign debt will take fright on those occasions when the authorities’ attempts to steer the ship appear to stutter. Volatility between asset classes will test our mettle, whichever way markets settle. This makes investing either very short-term or very long-term. The important thing is to watch out for the next bubble.



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