Markets spent much of early 2013 fending off unwelcome headwinds and most started the year in positive territory. Recently though, some investor bullishness has faded and we entered the second quarter with some of the early year euphoria beginning to wane. We started the year believing that there remained a significant opportunity in selective areas of cyclical value that had more than priced in the troubled macroeconomic environment in our eyes.
Exposure to domestic value in Europe and depressed Japanese large cap value have been positive and we have trimmed accordingly as gains have been made. With these gains, the valuation gap between areas of overvalued ‘safety’ and these once unloved areas has undoubtedly narrowed. However, we are not as yet in a position to believe it prudent to switch back to some of the more defensive areas of the market where we believe valuations still look relatively full. As one fund manager we speak to put it, “some of the consumer staple valuations look bonkers”. It’s difficult not to agree at this stage.
It is also interesting to note that while in the US – which appears to be heading the recovery – market leaders have included some of the more cyclical areas in which we’ve invested (housing, financials et al) this pattern has yet to be fully replicated elsewhere. In Europe, for instance, the more defensive growth names – the ‘Nestlés’ of the world – continue to power ahead. In short, much of what we own still looks relatively attractive on a medium-term view. Of course, should conditions change, then so will we.
Above all, we remain conscious of taking the appropriate amount of risk for our investors and the still volatile environment in which we operate. To this end, we continue to believe that while we are being offered the opportunity to take a degree of risk in equities, we can counterbalance this elsewhere in our portfolios. As such, we have continued to trim our credit exposure – particularly to areas such as high yield which benefit from the excessively loose monetary policy we see globally and that at these levels look less attractive than 18 months ago.
Government bonds remain a ‘return-free risk’ in our eyes, despite the ‘safe haven’ tag still applied, so we remain uninvested. What credit we do own remains in low duration, higher yielding credit where selective spreads still look relatively attractive. We view ‘fixed interest & cash’ as one part of our overall allocation so as a result of our trimming of credit and a lack of screamingly attractive alternatives, our cash holdings have risen. However, we continue to allocate our cash actively, benefiting from holding a proportion in the appreciating US Dollar, which we have subsequently trimmed. We continue to use our alternatives holdings to provide the protection and diversification that government bonds have historically provided.
With macroeconomic data and markets seemingly stalling once again, we are mindful of not taking unnecessary risks at this stage. But, on a risk/reward basis, we are comfortable that we can offer investors an attractive medium-term return from here.
Robin McDonald is fund manager of Cazenove Capital Multi-Manager Diversity range