As we enter the last quarter of what has turned out to be an eventful year, cross-asset class investors continue their search for the ‘best’ asset class. Without a crystal ball, it appears impossible to answer where this will be with any degree of advance certainty. It is therefore crucial to diversify by blending asset classes ideally including those which offer a positive yield.
The way the blend evolves over time is key for future risk-adjusted returns. Even if the starting point is a smart strategic asset allocation, effective navigation among asset classes is important along the way. At UBP Investment Advisors, our Investment Committee’s tactical views allow for tweaking of portfolio exposure based on convictions around risk-adjusted returns in the medium term.
As things stand at the time of writing, our positioning with respect to equity markets is neutral. Developed equity markets seem likely to lack direction going forward, with varying levels of performance for underlying sectors and stocks, as COVID-19 dynamics and scenarios for the US presidential election evolve. Further clarity on and actual implementation of stimulus measures should improve the outlook, while a weak response to pandemic-related economic damage would imply a further deterioration. We also expect low directional pressure within Emerging Market Equities. Related economies all find themselves at different stages of the pandemic. While they may possess a diverse arsenal of support measures, they also have varying degrees of exposure to international trade.
On the fixed income side, near-zero risk free rates for the US Dollar and negative ones for the Euro and the Swiss Franc make asset allocation more challenging. The Federal Reserve’s policy looks set to remain strongly supportive over the next few quarters. Even if the current economic situation suggests a lack of strong upward pressure, long-term Treasury yields should drift higher as the economy recovers. As long as they remain low, it may be wise to forego a small revenue stream in order to avoid adverse price movements. We therefore prefer cash and equivalent investments. The investment grade corporate bond segment still provides limited opportunities for diversification, while Treasury Inflation-Protected Securities no longer represent a bargain as inflation expectations have returned to pre-COVID-19 levels. They could nonetheless offer some upside potential if the Federal Reserve does allow for higher inflation figures in time. Credit spreads of sub-investment grade bonds also continue to converge toward pre-pandemic levels. However, as resurgence complicates economic recovery, defaults by low quality issuers may increase more than expected. It appears appropriate to maintain a cautious stance for the time being.
We choose to seek out some yield pick-up within Emerging Market debt, adopting a neutral positioning. Several Emerging economies look likely to suffer from deficits driven by the struggle against COVID-19 and its social and economic consequences. Their creditworthiness could consequently be at risk. Geopolitics can also play a role. On the other hand, as far as local currency bonds are concerned, related currencies hover at undemanding levels and the average yield remains attractive. Turning to hard currency bonds, the average market yield exceeds US Treasuries by a comfortable margin, allowing for income generation with limited risk at market level.
At UBP Investment Advisors, we also evaluate non-traditional asset classes such as Commodities, Gold, and Alternative Investments. Commodity prices have recovered more than half of the crisis-related drawdown overall. As recovery progresses, this pattern should persist. However, timing is based on factors like the geopolitical backdrop, stimulus implementation, and aggregate demand recovery. As for Gold, it has been trading sideways following the recent rally. The metal’s price should continue to benefit from heavily expansionary monetary policy, geopolitical instability, and any resurgence of the pandemic and its associated high uncertainty going forward. Alternative Investments have delivered low returns of late across the board. We believe that such a pattern is likely to continue, as low interest rates and illiquid holdings weigh on performance. We maintain our focus on convertible bonds, a simple solution when seeking some asymmetry in returns.
In conclusion, it appears useful at this point to keep some powder dry and to watch out carefully for relative value across markets or for overshooting if risk aversion returns. Seasonally speaking, the first year of a presidential term in the United States tends to be good for equities, and 2021 should also be supported by some additional factors. However, it remains unclear whether current levels constitute the appropriate entry point or whether the potential rally could start from lower levels.
- Vangheli Lakiotis, Senior Investment Manager, UBP IAS
Compliments of UBP IAS – a member of the EACCNY.