Since the start of this year, we have been slightly cautious on global equity markets.
Since the last significant equity correction in May 2006, markets have had an almost uninterrupted recovery as investors continued to favour higher beta assets, that is, 22/5/06 to 26/2/07 FTSE Mid caps +31.5 per cent, FTSE 100 +16.3 per cent. (Source: Lipper Hindsight – percentage growth total return, Net GBP).
It has been our view that due to the high levels of equity valuations and lack of pricing of potential risk, a more defensive approach was prudent as the market has continued to move broadly higher in 2007. With this in mind, we have continued to take profits in funds that had been leading the upward charge while adding to more defensive holdings and increasing cash during the first weeks of the year.
The actual timing of these short-term market setbacks are impossible to predict and while the catalyst for global investors to derisk or take profit within their portfolios can be almost anything from the unwinding of the well publicised yen carry-trade to Chinese government action to try and cool the over-valuation in the Chinese domestic market to a sell-off in the US sub prime mortgage market, with high global market correlation, the result is the same – a widespread correction led by the perceived riskier assets as investors derisk their portfolios and bank the profits they made in the prior months.
So, what should investors do when faced with these potential corrections? In short, we see these sell-offs as healthy and representing good medium to long-term buying opportunities for the market. While equity markets have recovered and are now back around the levels of the February correction, the future path of equity markets is far from a risk-free trade as it is unlikely that this will be the only sell-off that we see in 2007.
Increasing global asset correlation and liquidity means that these periods of sudden global sell-offs and market corrections are likely to stay for the foreseeable future, with the trigger increasingly hard to predict. This means that investors now more than ever need well diversified portfolios on a both geographic basis and by asset class.
In this environment, we continue to favour diversification and are retaining our bias to more fundamentally driven boutique-style managers who we believe have the necessary skill, desire and flexibility to deliver strong relative and importantly absolute returns for investors during these volatile conditions.
Scott Spencer is portfolio manager at Credit Suisse Multi-Manager Services.