By Morten Spenner, CEO of International Asset Management (IAM)
Here are our forward-looking investment views looking into 2013.
Market context – more constructive on the market environment
Overall, we continue to observe a global economy which is recovering and with investor sentiment increasingly reflecting this. The most noteworthy recent developments have been the effective ‘backstop’ put in place around the Euro by Mario Draghi, the improved economic figures out of the US as well as better-than-feared figures out of the BRICs, in particularly China. Whilst we anticipate that individual country/area recoveries will be at different rates, we recognise that this will not be a road without twists and turns and that so-called ‘event risks’ remain. In addition, we do not find strong evidence for a very bullish growth scenario.
To reflect this environment, we at IAM have reduced our Defensive holdings, increased our holdings of Variable managers whilst maintaining our level of Directional exposure.
Manager risk style characteristics
Directional
High returns and volatility over the cycle.
Seeking to benefit from market beta; high equity correlation.
High opportunism and low consistency scoring on IAM’s ratio grade analysis.
Variable
Moderate to high returns and volatility over the cycle.
Opportunity seekers focusing on generation of alpha.
High consistency and high opportunism scoring on IAM’s ratio grade analysis.
Defensive
Lower returns and volatility over the cycle.
Seeking to generate persistent returns irrespective of the environment and to outperform in market setbacks; low equity correlation.
High consistency and low opportunism scoring on IAM’s ratio grade analysis.
We believe that as progress continues to be made in the global deleveraging process, the main opportunity to be captured is in the form of strong security selection rather than by general market selection. Investor demand for risky assets has clearly increased and picked up rapidly in the third quarter. This is against a background where yields in traditional and liquid government bonds are unattractively low and therefore out-of-favour, corporate bond yields are also at lows and spreads have tightened whilst equities appear fairly priced. In this scenario, we favour the following investment themes:
Credit
Corporate bond markets continue to have a mix of companies with improving balance sheets and reasonable corporate profitability contrasting with over-leveraged companies in need of refinancing. Market inefficiencies have helped to create mispricings and enhance the opportunity set for long and short trades in both the investment grade and high yield markets. The compression in yields experienced during 2012 is now providing for more attractive entry points on the short side while the cost of running negative carry strategies has come down. In addition, many managers are finding value in bank loans as they offer interest rate protection and better security whilst trading at similar yields compared with high yields. Similarly, managers have also been able to add value through focusing on off-the-run securities. We favour managers with fundamental credit and balance sheet analysis skills together with technical trading experience.
Specialist Credit
Specialist managers within the Event Driven strategy who focus on niche areas of the credit markets have been able to provide strong returns in 2012. We believe this will continue. Structured credit markets such as RMBS have benefitted from strengthening fundamentals due to rising home prices in the US, improved loan modification success rates and downward-trending delinquencies. While RMBS has performed well in 2012, it continues to offer reasonable valuations, high single digit running yields and the potential for further capital appreciation. Technical drivers remain strong as lower spreads across fixed income markets have increased investor interest in search of higher yields from more complex securities. We also see the potential for strong returns to be produced by managers in this area with specialist knowledge of CLOs, bank hybrid debt, TARP securities and CMBS who can successfully security select.
Specialist Long/Short Equity
Managers that source profits from more idiosyncratically driven positions and have deep focus and knowledge in specialist areas within equity markets are more likely to produce positively differentiated performance. This category of managers includes sector specialists, small/mid-cap experts, country specialists and on-the-ground emerging markets players. Furthermore, managers that are flexible with their exposures should also be able to benefit from strong tactical trading abilities. We are now observing much lower correlations within equity markets as well as an increased focus on fundamentals. Therefore, we expect to see increased attribution resulting from stock picking in 2013. We thus continue to favour managers that can produce positive contributions from both the long and short sides of their books.
Conclusion
We will continue to diligently monitor the progress made in global economic growth, specifically in areas considered more ‘bright spots’ such as the US as well as potential detractors such as Europe. The political involvement with markets will continue to be a substantial factor. We anticipate more opportunities to arise from economies, sectors and corporates growing at different speeds and will steer our allocations accordingly.
For 2013, we expect our reduced Defensive positioning will support improved returns without jeopardising the robustness of our portfolios. We will continue to favour liquid, mid-sized managers sourced from around the globe to best extract value from market opportunities. These will be combined deftly in concentrated portfolios, allowing for manager skill to be expressed whilst ensuring a portfolio composition focused on capital preservation and the compounding of steady returns.