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Time to pay a bit more for diversification?

9 February 2021

Describing the equities outlook as ‘cautiously optimistic’, David Hambidge, investment director, Multi Manager Funds, Premier Miton Investors, looks at where investors can take advantage of the markets in 2021

We all know that forecasting is something of a mugs game (if in doubt just refer to mine and others from this time last year!). It certainly wasn’t the first time that myself and most others have been wrong and it certainly won’t be the last.

In spite of that, in order to determine your strategic asset allocation you have to have a clear view of the world (or at least as you see it).

As a starting point the top down asset allocation of our multi-asset funds depends on what each fund is looking to achieve and the level of risk that can be tolerated. In addition, for some mandates there are factors such as income that have to be considered. This is no different to how you might construct a portfolio for a private client and certainly helps in ensuring that you stick to the fund’s objectives.

This may seem obvious but you may be surprised how many fund managers don’t do this and instead go down the path of trying to be all things to all investors. A strategy that will nearly always come unstuck.

When thinking about asset allocation we never forget the lack of correlation (in the short term at least) between the global economy and asset prices. This is certainly true over the last twelve months where we have seen a sharp downturn in economic output but a year where most equity investors were rewarded handsomely (assuming they could stomach the volatility).

However, this of course can work both ways and while the large majority of economists are predicting a much better year for the global economy, that won’t necessarily result in higher equity prices given that it can be argued that a recovery is already well and truly discounted.

So the best we can come up with for equities is ‘cautiously optimistic’. Apologies if that sounds a bit wishy washy but like virtually every other asset class, equities have benefitted hugely by a tsunami of cheap money over the last year. Actually make that the last twelve years.

Where are the opportunities?

While equities can hardly be described as cheap, there will certainly be good opportunities for stock pickers to exploit even if the market as a whole does very little. We have certainly been encouraged by the significant pick up in share prices of medium sized and smaller companies in both the UK and overseas relative to larger companies. This is something of a return to the long-term norm although over the last few years large cap stocks have dominated returns which, of course, has benefitted tracker funds given the make up of the various major global stock markets.

We also think the future is much brighter for ‘value’ investors and given the mauling they received at the hands of the ‘growth’ fraternity last year, it is hard to see a repeat in 2021. Indeed value has been outperforming growth since the first vaccine announcement in early November, albeit the market will need more convincing that a return to some sort of normality is around the corner. However, when that happens we expect cheaper more economically sensitive value stocks to produce superior returns.

From a regional perspective we believe UK equities should perform better now that Brexit is out of the way. The UK was by some distance the worst performing major equity market last year in spite of a very strong last quarter and remains cheap compared with other markets and particularly the US where we remain extremely cautious (particularly large cap growth stocks).

While it is easy to make a bull and bear case for equities, I believe that it is hard to be anything but negative for bonds where at the last count investors were having to pay to own over $18tn of government and corporate debt. That said, many believe that bonds still offer good diversification benefits although I would argue that given the lack of yield support and vulnerability to rising interest rates, there will be many times in the future that they provide no diversification benefit whatsoever.

Finally, I read recently that multi-asset portfolios have performed poorly versus a hybrid 60/40 equity bond model over the last ten years. That is true and with the benefit of hindsight there has been no benefit in diversifying further than equity and bonds over the last decade. Given where valuations currently sit I do not believe that will be the case over the next 10 years and a diversified portfolio will be worth paying a little bit more for.

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