“As regard alternative investments, wealthy investors are currently showing keen interest by taking more calculated risks and more are interested in new ideas in that space. Many wealth managers are also continuing to expand private equity and hedge fund investments. Though liquidity is a negative factor for private equity, long-term prospects are very lucrative,” Gopal Menon expert at Markaz, said.
Investment management has greatly differed from pure economic fundamentals to more momentum plays, expectations and willingness to venture out before hurdles are cleared.
But there are still a few investment managers who resort to the traditional investment patterns basing their decisions on a strong economic numbers. Since 2008 crisis the gap in thought process between economists and investment managers started to widen more conspicuously when economists argued the Fed and Global Central Banks’ actions of supplying easy money will lead to eventual higher inflation and painful economic consequences, investment managers and investors considered this policy as a boon to capitalize on the liquidity situation,”
While deleveraging started on the private side, Governments started to increase their balance sheets significantly to rise themselves from the huge fall. This is a part of history now, though continuing.
Investors’ approach to investment started to take different twists and turns in the aftermath of the crisis. Initially they were with the economist’s view of deep recession, so moved assets to banks, but lack of returns at the bank forced them to switch swiftly to Treasury Bonds. Once the yield started to sink in T bonds, corporate credits were chosen. From there investors increased their risk appetite to adopt high yield bonds and structured credits/loans. Some of the investors found equities more tempting on account of their improvement in corporate earnings and hopes on eventual recovery in consumption and employment.
Today investors even look at stocks in troubled European nations, sub-investment-grade European bank loans, subprime mortgages and hedge funds which use derivatives and other complex mechanisms with high leverage. Though increasing exposure to risk is a matter of necessity now in pursuit of any decent return, there is no real method to mitigate the risk factors that can lead to unexpected reversals of fortunes.
An asset allocation where the fixed income takes the role of partly absorbing your shocks cannot have them today because every manager is now drastically cutting down the bond exposure out of concern of raising interest rates in the next 12-18 months. Instead an asset allocator can analyze the merits of alternative investment strategies and provide them a place in the overall portfolio allocation. That said, the alternative asset strategies can also go nasty because they use products of derivatives and high-risk low liquidity investments.
Let us look at the risk migration structure carefully and our ideas on future assets allocation. Initially the lack of returns forced the clients to climb the risk ladder from deposits to bills and bonds, but soon the fear of rising yields forced them to go to higher risk environment. This change of sentiment originated from the need for higher returns started to embrace the most defensive side of stocks, high dividend paying ones. Steadily and surely by the end of 2012 most investors have been putting a great deal of the wealth into equities, primarily US, Europe, Japan and selected Emerging markets.
In 2013 we are witnessing the rise of developed markets in significant terms confirming that the investor community is content with higher risk in the midst of low economic growth. Emerging markets stand on the opposite side of the arena with slowing but high growth and substantial risk on political and currency fronts. Investors have shunned the emerging markets not only on these reasons, but also on the prospect of Fed’s QE-tapering to begin. This will drive away lot of FDI money from Emerging Markets and it has already happened in July-August period. Especially the BRICs and countries that have more FDI investments suffered heavily.
As regards investment opportunities, many companies in recovering developed countries have excellent balance sheets, valuations are attractive and correlations between and within asset classes are lower than they have been prior to 2008 crisis. A change in investors approach to Europe this year after the better than expected 2nd quarter GDP led to post strong gains – the MSCI Europe Index has returned 25.2 YTD (Sept.2013). European banks historically traded at a discount to US, but now they are trading at even more discount.
Though Europe’s macro economy will remain subdued for years, the micro level is providing ample opportunities to stock pickers. The caveat for the European investor is that he might see at some point in time the currency Euro will weaken dramatically once the QE tapering is operational.
The next best market which investment managers consider is Japan because we have now started to believe that Abenomics will work in Japan and its reform measures will finally pave way for the long-term sustained growth. The recent upward revision to a 3.8% in second quarter GDP growth is encouraging. Exports have picked up and the profit potential of the companies has increased with the operating margins improving. But obviously the growth and economic prosperity in Japan will depend on a weak yen. Japan needs a weak yen to reduce its debt burden which is currently 240% of its annual GDP. Therefore, any investment in Japan has to have a shield for currency declines that can be more pronounced as growth edges up.
Emerging markets which used to be the gold mine of the past few years have been hit hard on fears of slowdown in growth. Primarily that can be one reason, but Fed’ QE- tapering fears, political instability and the on-going currency depreciation all have played a role in pushing the MSCI Emerging market to a negative territory this year (-6.4% as of 30th Sept.2013) contrary to the expectations of some economists and analysts at the beginning of the year. Still most investors are hanging tight with some reduction in exposure: some are of the opinion that this is presenting an opportunity to buy. The ‘frontier’ markets had an inflow of $37 billion this year. As the global economy improves, many of these nations with embryonic capitalist systems- like Albania, Cambodia, Mongolia, Angola etc. will benefit. This is still a long-term theme with lot of volatility, but opportunities are compelling.
Arbitrage opportunities, macro strategy and long/short credits and equities will all add a lot of value to hedge funds in current investment. The loan yields are varying between 7% and 10% which should look attractive to some, but the illiquidity feature should be taken seriously.
To sum up investors and wealth managers are steadily embracing more risk in their portfolios in pursuit of higher returns mostly in the form of capital appreciation. This trend though very positive and strong currently could suffer massive setbacks if inflation and interest rates rise more rapidly than anticipated. However, going forward, investors should raise the risk bar otherwise they may fall short on their goals.