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Bear essentials: The managers playing it safe

Amid the bullishness on equities, some managers are playing safe on the view that the asset class is vulnerable to sudden shocks

Equities appear to be the favoured asset class for 2014. But with some defensive managers arguing investors are underestimating the potential risks from monetary policy, continuing macroeconomic risks and sentiment driven markets, is there reason to be bearish? 

As the outlook for developed economies improves and investors’ appetite for risk shows no sign of abating, the majority of investors appear to be taking a positive view of markets.

The latest Bank of America Merrill Lynch fund manager survey from the end of 2013 shows overall global managers are bullish on equities.

Portfolio allocations to equities continued to increase to a net 54 per cent overweight, up from 52 per cent recorded as part of the previous survey in November.

But the survey also describes the popularity of risky assets as a “pain trade”, indicating the consensus view could fall subject to a shock in the year ahead.

Some investors have already opted to position portfolios for an alternative defensive view of both the macroeconomic backdrop and outlook for markets.

Long standing contrarian fund manager at Investec Asset Management Alistair Mundy is continuing to adopt a defensive stance for his £2.8bn Investec Cautious Managed fund despite the signs of growth in the global economy.

Mundy argues the market is currently more vulnerable to potential macroeconomic shocks given the high valuations of equities.

He says: “Valuations are generally high in equity markets which is odd given we are surrounded by great vulnerabilities and fragilities in the financial system. When valuations are stretched macroeconomic concerns become harder to ignore.

“Investors know there are risks but they are underestimating the spread of potential risks and overestimating their ability to react to potential risk events. The spread of outcomes in the consensus view is a lot tighter than we are considering.”

Mundy says the continuing fixation for “reading between the lines” of any announcements US Federal Reserve’s announcements regarding tapering the quantitative easing programme could see the market lose confidence both quickly and unpredictably.

He adds the distraction of QE tapering could see the market unprepared for other potential shocks, particularly in Europe.

He says: “Investors are more positive on the outlook for Europe but the structural issues still remain. Budget deficits are still reasonably high and consequently government debt as a percentage of GDP is still growing.”

As a result the fund is “very defensively positioned”, according to Mundy, with significant positions in cash and inflation-linked bonds, as well as gold as an insurance policy against a market panic over central bank policy.

Murray International Investment Trust manager Bruce Stout is also taking a similar defensive position on the belief that equities have become expensive without the essential support of fundamentals, thus risking a correction.

He says: “This year the first and most important priority is capital preservation because we know equities are expensive and there are no earnings and dividends as support.

“So just jumping on certain assets because this is what everyone else is doing will only end up losing people money. That is why we are behind the benchmark, because we are not going to get involved in this.”

In particular Stout points to the recent positive sentiment surrounding developed economics, which has seen some equity markets rise despite no underlying earnings growth.

He says: “If you look at Europe this year earnings growth will be down. So all market movement is 100 per cent multiple expansion. So you are paying a higher and higher price for lower and lower quality.” 

Earnings growth is also expected to be “anaemic” in the US and “muted” in the UK, according to Stout.

He argues emerging market equities, despite being considered a typical risky asset, continue to look attractive despite misconceptions the region is in crisis.

Stout says: “The polar shift in opinion toward emerging markets is having very little impact on a stock such as drinks distributor FEMSA in Mexico because the Mexican domestic situation is all about rising real income growth in a demographically young population.”

But for other traditional market bears, improvements in the global economy have seen them take a U-turn to form a more positive view of markets this year.

Famous bearish economist Nouriel Roubini says tail risks such as a hard landing in China or disagreement over the debt-ceiling in the US will become “less salient” in 2014.

Roubini has also shifted closer to the consensus view that developed economies will see further improvement in 2014, as well as emerging markets.

He says: “The good news is economic performance will pick up modestly in both advanced economies and emerging markets.”  

“The advanced economies, benefiting from a half-decade of painful private-sector deleveraging (households, banks, and non-financial firms), a smaller fiscal drag (with the exception of Japan), and maintenance of accommodative monetary policies, will grow at an annual pace closer to 1.9 per cent.”

Worldwide Financial Planning IFA Nick McBreen argues investors should always seek to take a more pragmatic view of markets and avoid piling into the “hottest new story”.

He says: “It is reasonable to expect continuing growth from equities but this must be tempered by a sense of reality as well as diversification to absorb any temporary shocks, rather than just going for the hottest new story which always ends up in tears.

“Taking a slightly more pragmatic about the market is what retail investors should always do.”


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