Positioning your investment portfolio in an unpredictable global market

There is a lot going on in global markets right now. Geopolitical tensions from trade wars and Brexit to the re-imposition of an embargo on Iran; and the uncertain outcome of removing central banks’ quantitative easing or emergency liquidity provisions are contrasted to the strengthening of the US economy and, prior to the re-emergence of volatility over recent weeks, new highs – despite fairly ordinary performances of stock markets around the rest of the world.

The path for investors from here is unclear. Opinions of strategists and fund managers differ markedly from intimating that all is good, earnings are growing, and profits are OK, to suggesting that we have too much debt and “the coming economic Armageddon is fast approaching”. This level of uncertainty is the foundation of our Investment Committee view that a diversified portfolio, which is exposed to a selected range of markets and assets, is the sensible approach to take in the current environment.

A mix of cash, different asset types and currency exposure balances risks and return

To illustrate this, consider portfolio exposure to the US dollar and US dollar earnings, along with exposure to Asian stock markets. If the US dollar continues to strengthen, supported by a strong US economy and rising US interest rates, the US dollar portion of the portfolio will likely perform well. However, a continually rising US dollar, particularly against emerging market currencies, may negatively affect the broader emerging markets. This could have some spill-over effect on Asian markets. In this scenario the Asian portion of the portfolio may not perform so well. However, a well-constructed portfolio of Asian shares with a bias to value will tend to limit under-performance in the strong US dollar scenario – while still performing well in a stable to falling US dollar environment, balancing out the portfolio.

If we could be certain that the US dollar was a one-way bet, we might reduce or remove our Asian exposure. We do not have that certainty. One possible scenario that we are watching that illustrates the uncertainty is that historically, when US interest rates rise strongly (as they have done) and the oil price more than doubles (which it has), then the US has a much higher risk of going into recession. In this case the US Federal Reserve (Fed) would reduce rates – weakening the US dollar.

Similarly, consider holding Australian equities alongside technology stocks in a portfolio. Australian stocks are over-represented with ‘old market’ companies (i.e. banks, property and resources) and under represented by ‘new market’ companies (i.e. technology and bio-sciences). A rising tech sector could leave behind even a well-constructed portfolio of Australian shares. However, selling all one’s Australian shares to go long tech-sector stocks would expose your portfolio to the sector’s very high valuation metrics, a predominance of US dollar earnings, low dividend income and the risk of disruption to the disruptors. Conversely, if we get a pull-back in tech valuations, it is likely that Australian shares will relatively outperform, supported by dividend income. A balance of the two sits well in a portfolio.

In an increasingly unpredictable world, it is better to make money steadily, than to lose it quickly

From an asset allocation perspective, similar decisions need to be made about the balance of exposure between financial assets such as equities, real assets such as property, alternative assets like private equity, and cash.

Financial assets have performed relatively well in recent times, however exposure to real assets can provide a level of downside protection – particularly if inflation rises, adding to the diversification of an investment portfolio. Cash returns are much reduced in the current low interest rate environment, but we cannot emphasise enough the importance of holding sufficient cash to reduce risk and also offer purchasing power to take advantage of corrections in asset markets without the need to sell existing holdings.

Our approach is to balance risks across our portfolios taking these considerations into account. While there’s little doubt if you get it right, taking a big bet on a particular market, asset or sector could bring reward – what if you’re wrong? A mix of cash, different asset types and currency exposure balances risks and returns. In a world that is increasingly unpredictable, we believe diversification is our best defence and it is better to make money steadily, than to lose it quickly.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward-looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick Broughton

Investment Committee Member

Patrick has 32 years of investment banking experience spanning over a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange.

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