Threat prompts allocation rethink

Panellists cut exposure to fixed interest and seek refuge in equities as the spectre of inflation draws closer - but fears of an emerging market bubble are also causing some circumspection.

Of particular concern is the amount of money moving into emerging markets. Although there is plenty of ground to make the case for the medium-term economic outperformance of many of these markets relative to developed economies that does not necessarily assuage fears that their equity markets will outpace underlying growth through huge foreign capital flows.

After several fund groups, including First State and Thames River, issued warnings of a potential bubble in these markets investors may have to revisit the case for investing.

“If the prompt for an emerging market crash is policy tightening or a reversal of economic performance there is probably no place to hide,” says Davies. “If, however, it is just a slow retreat of sentiment then the turn might not be so sharp. We’ve slightly reduced our exposure to those markets.”

Another sector that has received strong support is commodities, with the BofA Merrill Lynch survey showing a net 16% of global managers overweight the asset class. With the crude oil price edging back up to $100 a barrel and the gold spot price holding on to much of its recent gains it seems investors have had their heads turned.

Not only are they viewed as a potential hedge against inflation but also, in the case of gold, a store of value that sits outside foreign exchange movements. As the effects of extraordinary monetary policy in the form of quantitative easing (QE) by central banks are still yet to be fully understood, both of these characteristics present an appeal.
Despite the risks it seems the investors are still looking at 2011 as a potentially lucrative year.

“Equities aren’t looking too expensive yet as earnings have kept pace with rising markets,” says Yearsley. “Also inflation isn’t going to impact the economy too seriously unless the Monetary Policy Committee raises rates. The longer you’ve got QE [quantitative easing] and low interest rates the more money that is likely to flow into equity markets.”

Whether policymakers and investors alike will be able to avoid the pitfalls will largely depend on their ability to understand and anticipate one another. The past may be pockmarked by missteps in this regard but as every fund factsheet will tell you past performance is not necessarily indicative of future results.

_____________________

The Adviser Fund Index series – a summary

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/afi/).