Equities offer best route to play macro themes

A potential Greek default could be an ideal time for investors to increase equity allocations, believes Iain Tait, head of the private investment office at wealth manager London & Capital.

“People are looking to enter the market and the level of downside correction if Greece defaults could be bigger than anything we have recently seen,” says Mr Tait.

“Those with cash on the sidelines looking to redeploy could see a significant opportunity to increase their allocation to equities. We have never found a normalisation in asset allocation since the crisis.”

One of the big themes which L&C continues to back is the lower oil price, in the belief that many US firms will benefit from this, albeit with a time lag, rather than a simple equation of consumers seeing a cheaper bill at the gas pump driving straight to the mall to spend their leftover cash.

“We are stubbornly resolute in our conviction that the US will benefit, albeit with a time lag, from the hugely dramatic fall in oil,” says Mr Tait, who believes reduced spending on fuel will feed into a “wonderful consumer discretionary story.” Others, including ABN Amro, also expect an economic resurgence during the second part of 2015.

With L&C predicting a long deflationary period, the firm is, along with competitors, recommending clients invest in safe, income-generating assets, with equity taking a much more prominent role in portfolios.

“We are massively in the deflationary camp, which fits in with our thesis that interest rate rises will be shallower and take longer,” with the European Central Bank having “no chance” of hitting its inflationary target of 2 per cent, leading to a preference for “stable, predictable income, more now through equities as European bonds are in negative yield,” says Mr  Tait.

Swiss private bank Pictet has been telling clients they have been lucky to have it so good for the last five years, with equities averaging 20 per cent annual price growth, but that the end of the golden scenario is over.

Growth over the next five years will be positive, but relatively weak, predicts Luca Paolini, chief strategist at Pictet Asset Management. The bank favours investments in companies linked to digital technology innovation and is overweight Japanese and European equities.

“Japanese equities are quite cheap, the yen is one of the cheapest currencies on the planet and there is real structural reform going on there,” suggests Mr Paolini. “Even if we are not totally convinced with what [prime minister Shinzo] Abe is doing, Japan has never been investor friendly; you don’t need much change in sentiment to turn it around.”

Investing in 50/50 indexed bond-equity portfolios is no longer an option for private clients, as once inflation and costs are accounted for, such an allocation would struggle to make any positive returns.

“If you want returns today, you have to take risk,” ventures Mr Paolini, with a distinct lack of safe havens now available for portfolio planners. Swiss clients in particular like solid, dividend paying, big name companies, he says, “but I am not convinced they are safe any longer. If the market falls 40 per cent, they will still drop 35. There is no risk free asset that is very cheap.”

Even Mr Paolini’s traditional Nordic boltholes could come a cropper. “My favourite asset is still the Norwegian krone. In theory, Norway is the safest place on earth, but there is strong correlation with oil prices. These days, you have to be more tactical.”

The main challenge for private clients, leading to a renewed interest in equity investment themes, is how to deal with the end of the cycle in bond markets, confirms Didier Duret, chief investment officer at ABN Amro Private Bank.

Petrochemical companies are particularly good sources of dividends, he says, with a new relationship between bonds and equities now taking root. “Clients are now taking risk on their more opportunistic, bond investments, while looking to equities for their dividend income.”

But it is still too early for many to re-adjust to the “new normal”, believes Mr Duret. “Clients are not yet ready to go for a big reconsideration of their bond versus equity strategic allocation – for them it’s still a bridge too far,” he suggests. “Maybe after one or two years of living in the current paradigm, they will reconsider, but at the moment they will stick with a long-term proposition, which means investing in equities.”

Revisiting diversification is crucial he believes, with international equities beginning to outperform domestic stocks in Europe, mainly due to their sharper exposure to developing economies.

Currently, ABN Amro is following some general investment themes, favouring sectors such as healthcare and consumption. “We are not talking about narrow thematics any more, as the recovery is broadening,” says Mr Duret. “Clients were previously interested in micro ideas as the macro picture was ugly. Now that the macro view is improving, it will be interesting to look at bigger companies benefiting from broader trends.”

In terms of emerging market equities, most commentators prefer India to China over the longer term, although a cautionary note is also being sounded in some quarters. Swiss bank Pictet, for instance, likes the Philippines, India and Mexico, crediting them all with “solid reforms”, in the emerging markets universe, but with a generally “strong preference” for Asia over Latin America.

“India is starting from a much lower base and has some great companies and managements,” says Mark Mobius, president of the Templeton emerging markets fund. “But how do I know I won’t be charged capital gains tax on Indian stocks? They could wipe us out with this. India has some great companies and we want to put more money in, but we will be hesitant until they resolve this issue.”

At ABN Amro, the “call on China equities is older than our call on India,” admits Mr Duret. “China has had an extraordinary run and generated more profits, with volatility picking up, therefore we are rebalancing between China and India. The profits we take out of China, we put back into India. Volatility in China represents a good entry signal for India.”

“We really like India following [Indian prime minister Narendra] Modi’s election and are feeling increasingly positive,” says L&C’s Mr Tait, who introduces clients to the market through ETFs, allowing access to several “market vectors”. These include Indian mid-cap companies and also banks. “China we are more confused about,” he says, with a continued focus on managing a softer landing for the economy, which has now slowed to an annual growth rate of 7 per cent, from 15 per cent eight years ago.

It is safer, he says, to “play China through stocks not on the Chinese mainland,” buying equities listed in markets such as Taiwan, Malaysia, Singapore, Japan and Australia. “These surrounding economies can benefit from the Chinese growth story.”

Pictet is an exception in that the Swiss bank sees some benefit in direct investment into  China. “When I visit Shanghai, everybody is driving a new car, as people got wealthy during the last five years,” says the bank’s Mr Paolini. “Factories are now based in China, not because production is cheap, but because it gives them consumer exposure, with 100 per cent of production now for the Chinese market.”

As well as potentially investing in manufacturing, Pictet suggests a more subtle play on consumer finance. “There is also the question of how you finance the car purchase,” says Supriya Menon, multi-asset strategist at Pictet Asset Management. “In China just 25 per cent of auto-finance is arranged through leases, compared to two thirds in the US,” leaving much scope for expansion, particularly in a low interest rate environment.

Despite some cooling towards emerging markets by private bankers, Templeton’s Mr Mobius points out emerging countries are still growing at twice the pace of developed nations, at an average of 5 per cent, with Asian economies posting 6 per cent growth, even though GDP growth is not necessarily related to market returns.

He admits emerging markets have suffered for the last two years, underperforming developed stocks and affected by low investment inflows. Last year, the industry lost $55bn (€48bn) in net outflows from emerging markets, reports Mr Mobius. Valuations are now attractive compared to most developed markets, yet Mr Mobius is expecting a correction of at least 20 per cent in China, which he says “is nothing in this day and age”.

He urges investors to be selective and differentiate between countries, sectors and stocks, avoiding any temptation to label emerging markets as a single asset class. Russia is a case in point. “Our investments are constrained due to sanctions,” he says. “We are not allowed to buy a number of very nice companies, but we can still buy some which will do well.”

Templeton cannot for instance buy shares in Sberbank, Gazprom or Lukoil, even though Mr Mobius is a director of the latter. Similarly with Brazil, where the market is clouded with the corruption scandal at Petrobas, he feels “it is too early to give up” on a country blessed with oil, iron and agricultural commodities.

“Many said the World Cup in Brazil would be a mess, and that they did not have any chance to put it on successfully,” says Mr Mobius. “But if you have seen the Carnival in Rio, a most well organised event of huge proportions, with every Samba School directing 1,000 dancers and performers through a small area, you know these are very capable people.”

While growing wary of Malaysia and Indonesia due to corporate governance problems, Templeton’s favoured allocations are currently to Korea and Taiwan, with companies listed in the latter set to benefit from growing links with China. “This increasing inter-dependency is one reason you want to be in Taiwan,” says Mr Mobius.