State funds, family offices turn cautious on allocations

Sovereign funds, family offices and private bank experts explained how they are positioning portfolios for 2018 at AsianInvestor’s Southeast Asia Institutional Investment Forum.
State funds, family offices turn cautious on allocations

High valuations in global equity and bond markets are making allocators at state pension funds and family offices more cautious about the outlook for 2018, said speakers and other participants at this week's AsianInvestor Southeast Asia Institutional Investor Forum 2017 in Singapore.

Public markets, in particular equities, have soared in 2017. By the end of November, the MSCI World index was 20.8% up year-to-date, while the MSCI Emerging Markets index was 32.5% higher.

Bond indices globally have also generated decent gains as credit spreads—the extra income a corporate bond pays relative to the safest government bonds—have stayed depressed following years of record-low interest rates, even though US policy rates have begun to rise. 

Market valuations have consequently become more stretched, so unsurprisingly some asset allocators believe it is time to pare risk levels.

Mårten Lindeborg, chief investment officer (CIO) and deputy chief executive of the Third Swedish National Pension Fund (AP3), is one of them. “We are turning more defensive within the equity portion of our portfolio, and are considering reducing our exposure to small-cap stocks, which are highly pro-cyclical,” he said on a global investor panel at the event.

Between 2001 and 2016, the fund's total return after expenses has averaged 5.7% in nominal terms. It’s time to safeguard those returns, Lindeborg said. Given the market upswing gone on long enough and valuations are not in favour of investors, it is time to reallocate some investments, he said.
About 49% of the fund's $40 billion in assets was invested in equities as of the end of June 30, 2017. 

Lindeborg's caution was broadly shared by Asia-based asset allocators also at the conference. “We have trimmed equity exposures [and] are running a slightly higher cash position compared to previous years given the state of the global real economy and where interest rates are,” a senior executive of a Singapore-based multi-family office, who declined to be named, told AsianInvestor on the sidelines.

With interest rates in the US heading north—the Federal Reserve has lifted its benchmark rate to 1.25% from 0.25% since late 2015 and is projecting further hikes, possibly as soon as this month— tensions stemming from North Korea, and a potentially messy British exit from the European Union, there is a fair bit of uncertainty looming for financial markets.

On the other hand, the prolonged period of super-low interest rates and central bank-bond buying brought about by the global financial crisis almost 10 years ago has left markets awash with liquidity and boosted asset prices strongly.

Nadav Lehavy, managing director of the Singapore office of Sandaire, a multi-family office, told AsianInvestor: "As a long-term strategic asset allocator, our goal is to invest over the economic cycle, which is looking a bit stretched in larger capital markets [such as the US].” 

Another senior representative from a single-family office told AsianInvestor that her investment team is looking at rotation within asset classes and sectors, especially since the US market seems to be priced for perfection.

"We are also studying the implications of the proposed US corporate tax cuts to see which sectors and companies would benefit the most,” she said, adding that cutting back on US equities and moving money into less expensive markets was also an option.

US president Donald Trump’s proposals to overhaul US tax laws, which include a cut in corporate tax from 35% to 25%, won approval from the Senate last week, inching the proposals closer to becoming law.

However, the single-family office executive noted that up to 60% of the portfolio is likely to stay invested in equities. “What could change is the balance between private and public segments,” she said, adding that private equity currently accounts for around 12% of the total family portfolio.

A Natixis Investment Managers survey of institutional investors worldwide released on December 6 underlined those asset pricing concerns. It showed that 65% of respondents expect asset bubbles to negatively impact performance in 2018.

Apart from asset bubbles, geopolitical risk was seen as a key concern by 74% of respondents. Both ranked above interest rate increases (61%) as the factor institutions believe will have the most negative impact on their investment performance in 2018.

Craig Thorburn, head of emerging markets at the Australian government's Future Fund, said that one of the big challenges of 2018 will be figuring out how much risk to retain in the portfolio given the economic and market backdrop. “It is a difficult question when you consider the unique monetary, fiscal and even political policy experiments that are going on [in the world],” he said on an investor panel.

But has legs

For some at the conference, though, the market rally still has room to grow. Notwithstanding the relatively rich valuations in some equity markets, investors shouldn't be surprised if the current bull run lasts a few months more, said Bryan Goh, Swiss private bank Bordier’s CIO for Singapore, on the same investor panel. 

"Equity investors see valuations as high but not exorbitant," Goh said. Yield-starved credit investors, meanwhile, are also moving into equities, which could give the rally further legs, he added.

However, like other experts, Goh doesn't expect 2018 to be a repeat of 2017, given just how well markets have done this year.

Market valuations have been supported by improved corporate earnings growth across regions as global economic growth has grown more synchronised, but that could change, some experts have pointed out. 

“While we expect earnings growth to spread over most regions and sectors in 2018, momentum has probably peaked,” noted Sean Taylor, Deutsche Asset Management’s CIO for Asia Pacific, in an investment outlook released on December 6. “We expect earnings to grow between 5.5% and 16% for major markets in 2018, with emerging markets at the upper end.”

Asset allocators will doubtless continue to face a host of challenges as they continue to search for higher returns, but it is exactly in times like these that it becomes important to remind stakeholders, whether private clients or governments, that sustainable and profitable investing means mapping out a coherent plan and sticking to it.

"It's important to have an investment process and not be constantly swayed by the market noise," DBS Private Bank’s Christophe Marciano, desk head for discretionary portfolio management, said on the panel.

"Understand the time horizon of your client's investments and allocate accordingly. And finally, diversify across segments, sectors and asset classes."





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