In framing asset allocation policy our starting point is a top-down view of economies worldwide. Our asset mix reflects increasing growth forecasts for western economies and the prospect of an end to interest rate falls, but with inflation remaining within a modest, albeit higher, range. This is a scenario that we believe supports a preference for equities compared with bonds.
The US is the leader for world economies. While the high levels of growth seen in the past couple of years are expected to moderate, current evidence suggests growth will remain high, certainly above trend. Indications of a pick-up in inflation now bring forward the likely timing of any interest rate rise, if only as a demonstration of intent by the Federal Reserve of its continued desire to adjust monetary policy in advance of any sustained uplift in inflation. Rising interest rates will take their toll on the US bond market. This will be a negative influence on US equities, already expensive on valuation grounds. Any removal of the prop provided by new money flows would be a severe blow. One saving grace is the prospect of improved company earnings over and above earlier forecasts. This picture makes us wary for both bonds and equities in the US.
The picture in the US will spill over to the UK, where markets still tend to reflect events on Wall Street rather than in the euro bloc. So, in the belief that interest rates are at or near a trough, our portfolios have underweight positions in gilts, even though there is little evidence of any inflationary escalation as yet. Here the valuation argument has more foundation and both positive earnings momentum and increases to our growth forecasts support the case for an overweight position.
In Europe stockmarket performance has been a disappointment so far in 1999. A weak euro, a surprise in itself given market expectations at outset, has failed to provide the impetus for the major exporting economies, with Germany particularly hard-hit. On valuation grounds we find European equities as a whole fairly valued and we are left to balance short-term worries, particularly the effect on sentiment of further escalation of the war in the Balkans, with a more favourable background for the longer term. We take the view, however, that the scope for further corporate and economic restructuring means that the longer-term case for Europe remains intact.
If Europe was the disappointment in the early part of 1999 then Japan has been a relative star. The momentum came from overseas investors rather than from domestic sources.
We remain to be convinced that any further advance is well founded. We believe a crucial element in the improvement of the financial fortunes of the corporate sector in Japan is an efficient route towards the kind of restructuring seen in recent years, in the western economies. While there has been some erosion of the culture of a “job for life” in recent years the rate of change in labour markets and consequent cost-cutting seems likely to be slow. Until we are convinced that such restructuring is a widespread reality and not mere rhetoric our portfolios will remain underweight, apart from any short-term tactical moves.
Markets in the Pacific Basin have enjoyed a sharp increase so far this year and at current levels we do not view the prospects for further advance with any great optimism. Our portfolios are underweight in this area.
This then provides the broad market views we use to translate into asset allocation within our portfolios. It is our objective to add value through both asset allocation and stock selection even though we would usually expect greater differentiation in total return compared with competitors to emerge from stock selection.
One of the important factors that is crucial to the style of management we wish to promote is consistency and risk control.
The table gives an indication of an asset mix, compared with a benchmark that broadly reflects the mix held by pooled pension funds investing in stock market assets. This reflects our current market views and, we believe, maintains risk within an acceptable band.
Martin Clements is assistant director, Royal & Sun Alliance Investment Management in London