Portfolio construction, asset allocation, correlation, rebalancing and the CS survey of North American institutional investors
I like the CS survey of institutional investor meetings and have paraphrased their takeaways below. A conversation with an investor on Wednesday reminded me that investors need context to evaluate market views, opportunities etc. I provide example context for discussion in the form of core investment beliefs (right), an example of an Australian Endowment asset allocation (below) and potential agenda items for an investment committee in the current environment as follows:
- Rebalancing for the sharp appreciation of risk assets
- Confidence that defensive assets will appreciate and be liquid in a significant risk event
- Review of diversification and correlation assumptions - particularly with respect to Bonds, Gold, CHF and JPY
- Application of tail risk strategies
- Opportunities presented by the historical low of option prices
CS Global Equity Strategy Note - key takeaways
Periodically, Credit Suisse surveys large institutional investors in North America. In a Global Equity Strategy note published on Tuesday, they reported the following feedback from their marketing tour.
Three big takeaways:
- Many Investors have reduced risk
- Investors are looking to add to global emerging markets equities (GEM) and, to a lesser extent, add to UK equities
- US investors are now realising that ESG is becoming critical
Investors do not know how to quantify the negative impact and have been very wrong-footed by the market reaction. CS suspect that the hit to Chinese GDP could be significantly larger than consensus, but believe this is a postponement, not a cancellation, of a global recovery and that the policy response should make up for most of the shortfall in growth.
Many investors have reduced risk due to coronavirus concerns, the renewed focus on US politics, and the Middle East tensions. Despite equities outperforming Bonds (on CS risk-adjusted models), there have been US$122bn of equity outflows since the start of 2019. More clients than ever are wondering whether they should be focusing on the Equity Risk Premium (Equities relative to Bonds, as CS does) and not on Price-Earnings ratios. Both measures relative to history imply that investors are not positioned for higher equity prices.
They report very few investors who are negative on bonds and no one was really talking about the risk of higher inflation (despite rising wage growth in Europe). Many clients do not agree with the CS view that that fiscal easing will surprise in Europe on a two- to three-year view. Clients hypothesise that the ECB will follow the Riksbank and downplay the role of negative interest rate policies.
Global emerging market equities (GEM) were by far the most discussed region in the round of meetings. Clients want to build positions in GEM and are contemplating whether the coronavirus provides the opportunity. The clear exception was India, where there is near-universal caution, which CS thinks provides an opportunity. US hedge funds are re-engaging in the UK based on the view that both the currency and equity market are unusually cheap and on expectations of a rational trade settlement. To date, they estimate that only 18% of the post-Brexit referendum outflows have returned. The consensus positive view in UK equities is towards homebuilders. CS prefer construction exposure and small caps.
The UK optimism has not spread to Europe. US clients are looking for buybacks in Europe as a catalyst to add exposure. CS had no questions from US clients regarding Japan despite evidence of positive corporate change.
Growth versus value
This was the most discussed issue, particularly the valuation of growth. Some large clients see US growth as very expensive, whereas CS find that the P/E of growth in the US is still significantly below that seen during previous growth booms. CS recommends overweight US growth, but underweight European growth. Some clients agreed that European cyclical equities were very cheap (and consistent with PMI of 45, or 0% GDP growth).
US investors now realise that this tidal wave is about to hit and some are wondering how to alter their portfolios. CS advocate ‘E’ exposure.
Many clients have a (equities) barbell of technology (especially semis, which score very well on "E") and utilities. Concessionaires and construction are becoming consensus longs (correctly so, in CS's view). There was a surprising number of questions about whether "oil is the new tobacco" It has been de-rated as such.