While cash is generating near zero returns on a short term basis, and more than likely negative real returns on a ten year view, it is hard to get too excited about this asset class. However, currency allocation is the big driver in this space and with Emerging Market currencies having sold off in the second half of last year and still offering significantly better yield, this is our preferred currency area and cash play, in addition to US Dollars.
Our core global bond managers are now net short German Government Bunds and UK Government Gilts and holding predominately US dollars. The yields on Western Government bonds are now at a level (around 2%) that will almost certainly produce negative real returns on a ten year view unless further policy mistakes (not unlike those made in Japan) continue to be made in Europe and the US. History has shown us that if you buy government bonds at yields below 2.8%, you are almost certain to make no money and have negative real returns in the ten years ahead.
Most institutional liability matching strategies are currently advocating buying government bonds to match liabilities with yield and completely ignoring the valuation of such bonds. This is utter madness.
We believe that much better value lies in higher yield and emerging market bonds where either credit pickup, recent currency weakness or falling core inflationary pressures are evident and thus these assets offer good return potential.
As we stated in October last year, after twelve years of negative real returns, this asset class is starting to offer much better fundamental value and thus significantly better chances of achieving a 6.5% p.a. real return over the next ten years. Notwithstanding the still relatively high normalised earnings and profit margins, we have subsequently increased all our neutral strategic allocations to global equity as a result.
On a more tactical or annual view, there is no doubt that, after a difficult 2011, most lead indicators for the US and China appear to be positive. Whilst expected growth is not spectacular, avoiding a recession and achieving a soft landing respectively, appear to be the most likely outcomes. Europe on the other hand lurches from the application of one band-aid to another and this is what may end up dragging America and China down into the abyss before they are meant to get there.
Until orderly default terms are agreed for Greece and Portugal (and thus the others), it is difficult to be very bullish. There is no doubt, however, that the US job market is improving. Their housing is stabilising, risk appetite is rising and volatility is falling. Mean reversion from last year is very likely. Things are more certain now than last quarter.
The stability of earnings and cash flow are key positives for commercial property in the uncertain economic environment. The negatives are the debt overhand and the banks’ abilities, or willingness, to refinance current debt. This is such an important component of this asset class’s capital structure.
Asian commercial property still offers growth in rentals. Furthermore, fundamentals are solid. Some significant distressed NAV discounts and special situations still exist in the UK and Europe.
Ignoring gold bullion’s 10% rise last year along with oil, most base metals were negative in US Dollar terms. Assuming the US avoids recession, Europe avoids total meltdown and China achieves a soft landing, commodities should be a better place to be in 2012. We remain overweight gold but are looking for our exit price target this year. We see agricultural commodities as a better value play on the old new normal.
Hedge funds finished a difficult year with most mainstream indices down 5%. With the exception of the Trading Advisers and Macro Traders, most strategies did not do well. This asset allocation is best based around access to investment talent in a liquid and low correlation manner. Private Equity remains a high leveraged play on global growth and whilst significant discounts to NAV exist in many listed vehicles, we remain uninvested since the middle of last year.
JK Galbraith once said, “There are two types of forecasters: those who don’t know and those who don’t know they don’t know.”
The last quarter of 2011 was very difficult for global asset allocators as they experienced continued volatility and many multi-asset class funds finished deeply in the red for the year. JK Galbraith succinctly summarises what a fools game forecasting is but unfortunately we need to have a view for the year ahead.
Advisers and institutional clients will have sensed that we are more bullish and upbeat about return expectations on global equities for the longer term and more positive for “risk on” in the short term over the rest of the year. We are but it all depends on the Euro-zone and what happens there. The knock on effect could bring the global economy to its knees if people do not get it right.
Gavekal research is one of our valued global fundamental research sources and their velocity indicator chart has turned bullish for the first time in a while. The indicator remained quagmired deep in negative territory for most of last year. The change was more than likely sparked by better US economic numbers and the ECB’s Christmas gift of €500bn LTRO bank liquidity program (European QE II in sheep’s clothing!). None of this solves the big picture in Europe and disorderly PIGS default cannot be totally discounted, but the solid start for risk assets made in January may well have some more legs yet.