Tactical Asset Allocator: emerging market exposure on the up

The FTSE index recovered lost ground over July, moving back up to its mid-June levels, but fell again recently as the US-North Korean stand-off intensified and investors fled to safe havens such as gold and the yen.

No one yet believes a nuclear conflict is likely and we have seen similar posturing between Donald Trump and Kim Jong-Un before. Markets are therefore likely to bounce around in line with the rhetoric in the next few months, but any indication of a deepening crisis would cause carnage in the markets.

Trump’s credibility is now at an all-time low and his utterances increasingly make-believe and distorted. The administration’s vacuum on key policies such as lower corporate taxation is a rather more prosaic concern than world war, but the way Trump frequently pulls figures out of the air when talking about his plans suggests that these policies have yet to reach the drawing board. Ironically, his election promises that have been more effectively implemented – immigration and import controls – will both damage US productivity.

Before the feuding with North Korea became so heated, the Dow Jones index had enjoyed a strong run, posting nine straight days of gains in late July despite uncertainty about the strength of the dollar, which has already fallen around 10 per cent this year.

Rate rises loom

Business confidence is robust, leading to the possibility of further Fed tightening in the near term. The Federal Open Market Committee (FOMC) voting member Neel Kashkari was the only member to vote against the June rate rise and has been urging caution until inflation firms, despite the surprisingly strong gain in July job growth. The next big milestone will be the Jackson Hole symposium at the end of August, when we will hear the latest views of central bankers and policy experts.

Stock market growth over July was less pronounced in the UK than the US, but still evident, with the mining sector performing well on the back of stronger iron ore and steel prices. New Chinese regulations curbing steel capacity in the winter months have encouraged buyers to push their demand forward, driving Chinese steel futures to their highest levels in more than four years.

Uncertainty over Brexit also looms large and optimism has been tempered by the realisation that it is hopeless for Britain to take anything but a highly competitive pro-business stance to protect the economy in the years ahead, and worse – that this is patently not a vision shared by chancellor Philip Hammond.

UK investors have also been shifting their portfolios in anticipation of higher borrowing costs, as the Bank of England turns increasingly hawkish and opinion between the rate-setters begins to gape. Inflation has stayed in check and is forecast to peak around 3 per cent in October before falling back next year. This should give the BoE some breathing space, but the timing is hard to gauge given the Monetary Policy Committee‘s hints that the bank could hike sooner than expected.

Two members of the MPC voted in favour of a rate rise in August, down from three in June following the departure of hawk Kristin Forbes. However, in a BBC radio interview, deputy governor Ben Broadbent suggested the economy could cope with a small rate rise, as unemployment is at a 40-year low and wages are expected to rise.

The Bank must be painfully aware that if it does not raise rates in the next six months, its opportunity to stimulate the economy will have passed. The immediate risk to investors is a bond market rerating; but crucially, higher deposit rates would also help prevent a speculative bubble in limited risk assets such as infrastructure and P2P, which have become sought-after assets in a universe where there is very little choice.

Many UK headlines have focused on the plight of the UK equity income fund sector, where popular dividend-paying shares such as AstraZeneca and British American Tobacco (BAT) have fallen on poor drug trials and additional regulatory constraints respectively. The IA sector is heavily concentrated in a few mega-shares, and popular funds such as Woodford’s Equity Income have suffered.

Income investors should probably look again at smaller dividend-paying companies, global equity funds, emerging market bonds and property, where inflation-linked rentals offer some protection.

High-yield emerging market bonds cover a very broad range of regions, currencies, types of economies and credit profiles, and offer a higher average credit quality than their US equivalents. Furthermore, the indices that cover emerging market high yield corporates have a lower sensitivity to interest rates than broad developed nation high-yield markets.

Where Tactical Asset Allocator is investing
Higher
risk model
(%)
Medium
risk model
(%)
Lower
risk model
(%)
TAA portfolio's
asset allocation
(%)
Benchmark*
(%)
UK equities 20 20 15 13.2 35
Other developed
country equities
40 40 30 33.5 30
Emerging
market equities
20 15 15 27.8 0
Government bonds 0 0 5 2 17.5
Corporate bonds
(ex- high yield)
0 5 10 4.5 0
High yield bonds 0 0 0 0 0
Property and related 6 5 10 5.1 5
Precious
metals/commodities
3 2 0 3.2 0
Hedge funds/
private equity
9 3 0 0 7.5
Other
(prefs/convertibles)
0 3 5 0 0
Cash 2 7 10 10.7 5
Total 100 100 100 100 100
*FTSE WMA Balanced,index
Source: Interactive Investor, as at 10 August 2017

 Our portfolio is overweight to emerging markets at nearly 28 per cent, and despite the uncertain political climate, a high allocation to these markets remains the most attractive long-term opportunity for generating growth. However, it does mean that instead of buying EM corporate bonds, we are going to allocate cash to an ETF focused on EM government bonds, the iShares JP Morgan EM Local Currency Bond ETF (LEMB), which will help diversify the portfolio beyond the EM corporate world.

If the US is now a nation where little of what officialdom says about the economy can be trusted, China’s thrust is the other way, towards greater openness and transparency. Despite events such as the circuit breaker put on the Chinese A-share market in January 2016, and capital controls subjecting foreign transactions of more than $5 million to mandatory pre-screening by regulators since November, China is engineering a capital markets revolution.

The opening of the Shenzhen-Hong Kong stock connect last year, and the recent inclusion of Chinese A-shares in the MSCI index in June, mean that long-term globally diversified investors should be sure to set an appropriate allocation to the country.  

Gold prices have already been pushed up by tensions between the US and North Korea, most starkly after Kim Jong-Un responded to warnings from Trump with a threat to strike the US territory of Guam. There may be more spikes to come if the conflict intensifies, but most of the upside is already in the price. Although we have become accustomed to talking about gold as a ‘store of value’, as a long-term hold it is generally disappointing, useful only to cover sporadic episodes of plummeting market sentiment.

Tactical Asset Allocator Portfolio Constituents
Stock EPIC Category Risk Level*
Quantity
Price
paid
(£)
Current
price
(£)
Current
value
(£)
Weighting (%)
Lyxor ETF
FTSE 250
L250 UK
equity

81

1000

12.32

24.11
24,110
13.26
iShares Core
S&P 500
UCITS ETF
CSP1 US equity 110
100

103.70

181.40
18,140
9.98
Euro Stoxx
Total Market
Growth Large
IDJG Euro equity 104
525

18.14

31.07
16,309
8.97
iShares FTSE
EPRA/NA Glbl
PropYld (2)
IWDP Property 84
402

13.38

19.87
7,986
4.39
Neptune
European
Opportunities
NEOA Euro equity 104
1097

3.62

6.39
7,013
3.86
DBX MSCI Russia
25% Capd
XMRC Em mkts equity
214

400

17.64

17.61
7,042
3.87
Schroder Frontier Markets
Equity fund
M9S0 Em mkts equity n/a

80


100.00


121.39


9,711


5.34
iShares Japan
Sterling
hedged ETF
IJPH Japanese equity 139
200

47.41

54.12
10,824
5.95
Standard Life
Investments
Emerging
Market Debt
GU4Z Bonds
58


1300

5.15

6.35
8,249
4.54
DB X-Trackers
MSCI India ETF
XCX5 Em mkts equity
143

900

6.59

9.07
8,160
4.49
DB X-Trackers
MSCI EM Asia
Index UCITS ETF
XMAS Em mkts equity 129
420

24.12

38.42
16,136
8.88
iShares Global
Clean Energy
ETF
INRG Global equity n/a 300 3.59 4.09 1,226 0.67
iShares China
large cap
FXC Em mkts equity n/a
100

81.66

95.14
9,514
5.23
iShares
Physical Gold
SGLN Commo-dities n/a
300

18.26

19.29
5,786 3.18
Polar Capital
Global
Insurance fund
NAU4 Equities
99

400

5.35

6.04
2,417
1.33
Ground Rents
Income IT
GRIO Property n/a 1000 1.41 1.28 1,283 0.71
iShares
Automation &
Robotics ETF
RBTX Equities n/a 1000 4.66 4.98 4,981 2.74
iShares J.P.Morgan
EM Local
Currency Bond
LEMB Bonds n/a 100 36.59 36.59 3,659 2.01
Cash (see below) 19,247
10.59
Total 181,792
100.00
Notes: Portfolio start date 10 August 2012. * Risk level is produced by FE Analytics and references the FTSE 100 as benchmark of 100. £10 standard Interactive Investor dealing charge and 0.5% stamp duty deducted from cash holdings on new purchases and sales.Cash at beginning of period =,£22,906.21. Dividends this period:1000 Ground Rents Income Fund X 0.980p = £9.80. Cash before sales = £22916.01:purchase of 100 shares in LEMB = £3,659; dealing cost £10; cash remaining = £19,247.01. Source: Interactive Investor as at 9 August 2017

Keep up to date with all the latest personal finance news and investment tips by signing up to our newsletter. Email subscribers will also receive a free print copy of Money Observer magazine.


Subscribe to Money Observer magazine

 

Comments

Post new comment

The content of this field is kept private and will not be shown publicly.
By submitting this form, you accept the Mollom privacy policy.