Repositioning portfolios for a post-pandemic world
Asset allocators are reducing bond exposure in favour of equities and increasing exposure to Asian assets as they prepare for life after Covid-19
Portfolio strategists and economists across the globe have been busy recommending revised asset allocations and identifying investment megatrends, as the world begins to look at a post-pandemic ‘new normal’.
For private banks and asset managers serving wealthy clients, there is a consensus around three key changes: a re-allocation of assets from bonds to equities, a move from US to Asian markets and a preference for consumer-led cyclical stocks over defensive companies. But while most agree to reshape their client portfolios along these parameters, there are also many nuances to the latest strategies.
Opportunity knocks
“Covid distorted the world economy on the way in,” says David Bailin, Citi Private Bank’s global head of investments. “Now it will change the price of every asset on the way out.”
The shift in market dynamics will create a raft of tactical investment opportunities, according to Citi, as recovery from the virus-induced recession is fuelled by an acceleration of the digital revolution, combined with an unprecedented $12tn fiscal stimulus from world governments.
These catalysts, working against the backdrop of 5bn vaccine doses administered during 2021, should facilitate refilling of global supply chains, boosting GDP to “above trend” levels in all developed markets, from the second quarter of 2021, believes Mr Bailin.
Source: PWM's Global Asset Tracker 2021. Conducted in January, the survey canvasses views of chief investment officers, heads of asset allocation and chief market strategists at 50 private banks, together managing more than $13.5tn in client assets globally
His data points to a significant change in market behaviour, enabled by a prolonged period of low interest rates negating the purpose of holding fixed income and a “mean reversion” trend favouring cyclical stocks over the healthcare, IT and communications companies that have recently dominated the global economy.
“Currently, we are aggressively overweight equities,” says Mr Bailin, suggesting the traditional 60/40 equity/bond split should find a new balance closer to 70/30.
“The ability for government bonds to provide even a modest coupon and maintain the cushion they have provided in downturns is a concern post the 2020s bout of monetary easing,” agrees Vipul Faujdar, head in sales for SPDR ETFs at State Street Global Advisors.
“We would estimate a 20 to 30 per cent exposure in fixed income is more typical nowadays. The likes of infrastructure, broad commodities and particularly gold saw large allocations in 2020.”
These overarching portfolio shifts, say private banks and asset managers, are happening alongside a focus on “unstoppable” or “mega” trends. For Citi, these include transition to a greener world as the price of climate-friendly energy undercuts fossil fuels; ‘hyper-connectivity’ from exponential increase in devices and data; a new era of competition between the West and China, further fuelling the rise of Asia, now representing 40 per cent of the global economy; and a longevity-led interest in healthcare, beyond the Covid shock.
“Within equity portfolios, it is particularly important for clients to access unstoppable trends,” says Mr Bailin. “As well as hyper-connectivity and overexposure to Asia, they can benefit from significant changes in healthcare and greentech.”
Unlike in previous eras, many more of these thematic megatrends are now easily accessible for private clients. “There has been a huge rise in thematic ETFs being brought to market as changing future trends become more of a focus,” says State Street’s Mr Faujdar. “People want to get ahead of the curve and whether that is clean energy or increased digitalisation, there is an ETF available.”
Word of caution
But not every forecaster shares this enthusiasm for equities, with concerns about vaccine efficacy and rollout efficiency. “In the course of the last 10 months, we have learned a lot about how to deal with the disease and the mortality is falling. What is at stake right now is the ability of the healthcare system to support the pressure from increased infections and hospital admissions in the short term,” says François Savary, chief investment officer at Swiss wealth manager Prime Partners.
“This is why I am not buying into the scenario of being too positive about the economic recovery, and the speed of this recovery. I like the idea of the recovery and have believed in it for a long time, but I disagree with those people who say we will grow faster than expected because of the vaccine.”
Prime Partners and other wealth managers in this cohort also believe geopolitical rivalries will play as strong a hand in determining the make-up of investors’ portfolios as the economic trends relied on by Citi.
“When it comes to soft power, nobody can deny the US has lost the battle of Covid over the past year,” says Mr Savary. “The way we are positioned in 2021, overweight emerging equities, mainly Asia, is because we believe the ability of Asia to control the disease and reduce its spread has been much better than what we have experienced in Europe and US.”
At current growth rates, Prime Partners expects Asia to represent 50 per cent of global GDP by 2030. Its faith in Chinese equities is reflected through recommending the UBS China Growth fund, focused on domestic consumption stocks, favoured by the recently enacted ‘Dual Circulation’ policy, diversifying the economy away from exports.
“The Chinese are looking to grow two ways: through technological innovation and through domestic consumption to limit any sanctions from other parts of world,” says Mr Savary. “So we are looking at investment stories in China that relate more to the consumer and less to the technology issue.”
Mr Savary is also concerned about government clampdowns against tech entrepreneurs, as seen with the temporary disappearance of flamboyant Alibaba and Ant Group founder Jack Ma. He fears China could go down the Russian route, where political elites strangled an increasingly powerful business elite, jailing Yukos CEO Mikhail Khodorkovsky and exiling other oligarchs who had built businesses. This, he says, destroyed innovation in Russia for 20 years, as the country failed to modernise and re-industrialise.
“The problem today is of the political system in Russia or China being under threat if they let the private sector become too powerful,” says Mr Savary. “But down the road, this could lead to limiting innovation, prosperity and potential of an economy to grow at full potential.”
Other commentators believe concerns about China, the only major economy to post positive GDP numbers in 2020, are exaggerated. Although badly handled, the Chinese authorities’ warning shot to Mr Ma and the delay of his ANT group IPO also served a regulatory purpose, says Sharmila Whelan, deputy chief economist at Hong Kong-based research house Aletheia Capital, advising institutional investors.
“This was clearly politically motivated due to Jack Ma’s speech before the IPO. But what is the government trying to do? They wanted to bring in risk management and due diligence, which is absolutely correct.”
These measures, she believes, will help make the Chinese market more transparent and less prone to volatility and manipulation. “Today, it is all about resilience of the financial system. Ever since the shadow banking crisis, the Chinese authorities have been trying to substantially improve the regulatory oversight to avoid problems down the line.”
The competition between China and the US has swung so far in China’s favour that China is now “the only story in town”, as Ms Whelan puts it. “It is great that Joe Biden has become president, but the pandemic is not under control in the US.”
Although she sees positive signs about increasing European unity, Aletheia is not yet recommending vast European allocations to its clients. “In Europe, the €750bn ($905bn) recovery fund is an excuse to issue debt forever. Reform is now on the back burner. The only voice of reason from Europe – Angela Merkel – will soon be gone. French president [Emmanuel] Macron will now be the longest standing European leader. So we are not in a hurry with Europe.”
Prime Partners, along with Citi, are far more optimistic about European equities, showing strong faith in both the symbolism and effectiveness of the recovery fund. “This the first step towards sustainability of the euro project,” argues Mr Savary, adding European indices are tilted to cyclical and old economy stocks, compared to US-led tech, whose valuation is overextended.
Bright spots for bonds
Despite the consensus view on overweighting equities, there are still many bond-lovers left in the fund management ecosystem. Some believe trends towards environmental, governance and social investing can be particularly well leveraged in a fast-changing fixed income fund universe.
“In Europe, we are regularly seeing wealth managers bring out ESG model ranges to replicate their core models in a sustainable manner,” says State Street’s Mr Faujdar. “In fixed income around 60 per cent of the new ETF launches in Europe had the ESG tag on them in 2020.”
US fund manager MFS was one of several firms to boost research capabilities over the last five years in the belief that fixed income will remain a key priority for investors going forward.
“We believe this constructive stance has been vindicated, with global bonds producing strong returns especially in the last two years following the end of the Fed’s tightening cycle in 2018 and the onset of the Covid-19 pandemic,” says Owen Murfin, institutional portfolio manager at MFS Investment Management.
Currently the firm finds value in fixed income sectors including European financials and sectors where cyclical and Covid-related risks are priced in, such as certain automakers and capital goods names. “We still believe fixed income provides a key diversifier to riskier asset classes such as equity and commodities.”
