The Adviser Fund Index rebalancing in November was in many ways as notable for what failed to happen as what did happen.
With so much coverage analysing the relative strength of the developing world against sluggish developed economies, it is perhaps surprising that panellists resisted the temptation to significantly increase their allocation to the Asia/Pacific region.
Chelsea Financial Services managing director Darius McDermott says that to some extent, this reflects the trend in emerging market investment, with many investors choosing to gradually move money into these markets.
He says: “Our client portfolios tend to be historically overweight UK equities. As time has gone on and the prospects for the British economy have become stretched, more money has been moved into Asia but it has not been a flood.”
The recent rally in Asian equities has given many panellists pause for thought. With the Chinese government already having shown its commitment to restraining inflationary pressures by increasing bank reserve requirements in the past, the news that inflation is currently at its highest rate for two years has done little to quell fears of further tightening.
Ashcourt Rowan head of research and fellow AFI panellist Tim Cockerill says: “I think people should be wary of a possible bubble-type situation. Interestingly, First State are coming across quite negative on the prospects for emerging market equities in the short term. My concern would be that you are seeing rich valuations at the moment and you could get a severe setback quite quickly.”
First State’s Asia Pacific leaders fund is the most popular fund in both the Aggressive and Balanced AFI portfolios, chosen by eight and nine panellists respectively. Despite its focus on traditionally volatile markets, it is also the fourth most picked fund in the Cautious portfolio, with six panellists including it. That the group is suggesting a cautious approach to investing in these markets is certainly significant for AFI panellists.
Part of the problem highlighted by First State is that loose policy in developed markets has left a pool of liquidity. Many investors, flush with capital, have been lured by the potential of greater gains in emerging economies.
Without capital controls being introduced, there are few tools available to policymakers to prevent this haemorrhaging of liquidity. What it does indicate is that investors should treat excessive returns in emerging equity markets over the short term with a degree of scepticism.
Cockerill says: “If you had a slowdown in China, then everyone would feel it but markets can run on for much longer than logic would dictate. My guess is that we will be in a position where value is much harder to find but I suspect the upwards trend is likely to continue.”
McDermott says one of the things to watch out for is the foreign exchange benefits of investing in some of these markets.
He says: “An allocation to Asian equities not only gives you access to the fastest-growing region of the world but also gives you exposure to local currencies. I do not think Asian equities look particularly cheap any more but I think the currency uplift will mean the outlook for the short to medium term is still positive.”
Whatever the case proves, it seems that the structural risks that many economists placed at the core of the financial crisis are still present. Without a more honest discussion of necessary economic rebalancing in sluggish developed economies, these risks are more likely to grow than diminish.