WHILE we remain cautious about the coming months and are positioned accordingly, we see the market environment slowly improving. Improving economic data, better than expected corporate earnings, fair equity valuations and low interest rates are all supporting equity markets and the longer-term global recovery. We still maintain that a global recession will be avoided and that the US and Eurozone leaders will get it right in terms of monetary and fiscal policy. We also maintain that emerging markets will continue to grow, albeit slower than the markets had priced. Our sense is to watch geopolitical, economic and market events very closely over the coming weeks and months and to look for suitable entry points once all the dust around the Eurozone debt crisis has settled. It’s important for investors to understand that volatility and risk will likely increase going forward. Return expectations need to be more realistic. Risk, diversification and liquidity will continue to be key considerations. There are 10 basic rules investors need to follow:
1 Keep 30 per cent in cash. In a Black Swan environment all major asset classes become highly correlated and cash becomes the only real diversifier to market risk. Traditional asset allocation and portfolio diversification goes out of the window. The only asset class not impacted is cash. All cash and cash-like investments should be in your base currency only. So called carry trades in non-reference currencies are speculative in nature. Investors also need to remember that chasing yield in this environment is the worst thing possible.
2 Keep up to 10 per cent in gold but we would not be allocating new money in the current environment. Gold remains in bubble territory and any new money allocated tends to be speculative in nature. When the market recovers investors will sell gold in order to reallocate to riskier assets.
3 Don’t own government bonds with more than two years in maturity. Depending on your base currency, stick to UK Gilts, German Bunds and US Treasuries only. High investment grade corporate bonds are an alternative offering better yields than current cash rates and the yield offered by short dated government bonds. Above all investors should avoid taking credit risk and interest rate risk in this environment.
4 At least 80 per cent of your portfolio should be liquid, not because we think the world is falling apart but rather because there will be some amazing buying opportunities for investors once all the dust around the European sovereign debt crisis has settled.
5 Total fees should be below 1 per cent. This includes management fee charges, execution costs, custody fee charges and any retrocessions or rebates, which should always be returned to you as the client. Make sure you ask questions, understand charges, and reallocate where charges have become excessive. Remember that fee leakage over the long term equates to wealth destruction.
6 Don’t panic or overreact to geopolitical events. The financial media and markets have become too bearish. Things are not great at the moment, but there are some positive signs that things will get resolved and markets will improve longer term.
If you can allocate to real estate, hedge funds and private equity within your portfolio, then keep your exposure to below 10 per cent. Remember exposure is a leveraged play on the global markets. Understand the qualitative and quantitative risks to which you are exposed. Liquidity is also a key consideration.
7 Commodities and emerging market exposure is key – we recommend around 15 per cent into oil and agriculture. In commodities and emerging markets we have become more constructive.
While investors are concerned about geopolitical risk, inflation and asset price bubbles, emerging market equity valuations have moderated in recent months and broad based commodities have traded off their lows. Commodities and emerging market exposure is a play on the eventual global recovery.
8 Large cap global equities – we recommend around 15 per cent exposure. In equities we remain cautious in the short term. Longer term we are encouraged by fair equity valuations along with recent third quarter earnings numbers and guidance. We also see signs of central banks and sovereign wealth funds gradually selling US Treasuries and reallocating to riskier assets.
9 Limit your exposure to banks and financials irrespective of asset class. The sector looks fragile and is vulnerable to geopolitical events around the European sovereign debt crisis.
10 The primary focus for investors remains wealth preservation; it’s about return of capital not return on capital. Investors should stay focused on fundamentals. Do not trade. Do not speculate. Do not get caught up in all the short-term noise around recent geopolitical events.
Yogi Dewan is founder and chief executive of Hassium Asset Management