The case for putting more money to work in equities has weakened as we approach mid-year, say some asset consultants in the Asia-Pacific region, who instead see asset owners scaling back their exposure to risk assets or re-weighting their portfolios.
“My clients are re-assessing risk, and there is plenty of it within fixed income as well,” said Adeline Tan, head of advisory at Mercer in Hong Kong.
“So for now there hasn't been a wholesale increase to equity allocations,” she told AsianInvestor. “Where there have been changes, it is more looking at regional allocations as opposed to global or domestic; for example, European equities as opposed to global equities, and emerging markets as opposed to greater China.”
The reason for the change of sentiment towards risk assets has to do with the perceived effects of an expected tightening of liquidity in the US and China, which points to a downturn in the second half of the year.
“The general outlook is for risk assets to achieve lower returns. At the same time, bond yields are reversing a 35-year trend, meaning that the defensive attributes of bonds are compromised,” Tan said.
For Australian asset owners, the pattern is much the same.
Chris Trevillyan, director of investment strategy at asset consultancy Frontier Advisers in Melbourne, told AsianInvestor: “Progressively across our client base, the general direction has been to reduce equity allocations over recent months. I am not aware of any client making large increases to equity allocations.”
Frontier is more positive on emerging market equities, he said, pointing out that some clients have moderately increased allocations here because, in an environment of improving global growth and earnings, they provide more attractive relative valuations.
Trevillyan highlights one Australian superannuation fund that is reducing its equity allocation and, more significantly, increasing its options position, so its delta exposure to stocks is materially lower than a year ago.
“A number of our clients have been buying option protection and, given [that] current market volatility is very low while the level of uncertainty is high, option pricing seems reasonable today,” he said.
Alternative strategies are the one asset type gaining meaningful traction amongst institutions in Australia, according to Frontier. These include alternative debt in various sub-sectors, such as high yield, emerging markets, private credit and bank loans. Now though, as credit spreads have contracted, the market is near its cyclical peak, so allocations could soon be cut, Trevillyan said.
Frontier advised clients in early 2016 to have an overweight position in equities, but it is now more neutral on equities.
Heightened risks
Trevillyan added that the medium-term outlook would turn bearish if commodity prices moderated and/or volatility increased. “And there are heightened geopolitical risks, although to date markets have been relatively unaffected by events,” he said.
Tan said clients are right to be wary of the increased market risks. “The data is telling me to expect the unexpected,” she said, adding that clients who had met their investment targets were now more focused on capital preservation.
“We have one defined benefit fund client that could afford to reduce risk by increasing their cash allocations, whereas clients with more traditional return objectives are actively looking to deploy most of the time.”
Trevillyan acknowledged that a retreat to cash carries its own risks to portfolio returns, but supports larger cash balances at this time, on the basis that "cash provides increased flexibility to reallocate in the future and will not produce a negative return, which may not be the case for government bonds in a rising interest rate environment."
The chart below, sourced from Morningstar, shows how differently weighted portfolios have performed and, in particular, shows the benefits of having a high weighting to equities in 2016. For funds that have performed well thanks to that bold approach to equities, the challenge is how to keep that going.
