Uncertainty among investors may still result in some extreme market reactions in the short term but long-term investors need to remember to focus on asset valuations, such as price/ earnings ratios for equities, as they are one of the most important determinants of long-term returns.
Looking at valuations, long-term investors are being offered the chance to buy riskier assets, such as equities, at very attractive levels. For example, 12 months forward p/e ratios for developed and emerging market equities are currently close to their 10-year lows. Over the last few months, investors seemed to be willing to recognise this again and we have seen an almost 25 per cent return in US equities since early October.
Even in times of elevated uncertainty, we believe it is important to remain invested in markets to benefit from such market movements After all, while the present environment points to slower growth, it does not indicate zero growth. We expect 8.6 per cent and 7.5 per cent GDP expansion for China and India respectively this year.
However, it is equally important that investors spread their holdings across different regions and asset classes, for example equities and bonds. In addition, costs of investing have to be considered, in particular with the RDR approaching.
For investors, the most cost- efficient way of building a globally diversified portfolio is through index products, such as exchange traded funds or index-tracking funds. These will not provide the opportunity of achieving a return superior to the market but a well diversified portfolio of passively managed products will provide access to the main asset classes while keeping costs relatively low.
In particular, such a portfolio enables investors to benefit from the potential opportunities offered by current valuations of riskier asset classes, when at the same time, investors would have some kind of buffer, for example through government bond exposure. The very low absolute returns that developed market government bonds currently offer look poor value on anything other than a short term view but the asset class is usually in demand when risk aversion increases, and is an important diversifier in a global portfolio.
But looking purely at valuations within fixed income, we believe corporate bonds and, in particular, global high-yield bonds offer better total return potential, relative to developed market government bonds. In addition, most corporate balance sheets look healthy and cash levels are high, enabling many companies to stockpile cash in recent periods, building their balance sheets as a pre-emptive defensive measure. We feel it is worth remembering that when investors fled corporate credit last year in favour of government risk, this left the bonds of some profitable companies undervalued, which could provide opportunities.
Meike Bliebenicht is co-manager of HSBC world index funds