There is an important change in leadership happening as developed markets drive the positive momentum behind global growth. The US is pushing to grow between 2.5% and 3%. Europe is moving out of recession – although we expect no more than 1% to 1.5% growth in 2014. Japan we expect can grow by around 1% to 1.5%. Emerging economies will continue to anchor global growth at between 5% and 5.5%, but it remains a decelerating trend.
Q: What advice are you giving clients on their fixed-income allocation?
We’ve told clients to keep it simple and stay with shorter-maturity bonds. We are underweight fixed income and laddering short-maturity bonds – with target duration of 2 to 2.5 years. We continue to own extended credit, including high yield and loans, but far less than we have in previous years.
Q: To what extent will absolute-return investments have a place in a client portfolio in 2014?
Last year we did a rotation out of traditional fixed-income benchmark-aware strategies into strategies that take underlying market risk with greater tracking error – but they are effectively still long asset class beta. We are also overweight hedge funds – where appropriate – funding the overweight from fixed income. In hedge funds we continue to favour event-driven, distressed and long/short strategies – targeting an underlying beta similar to extended credit.
Q: What regional opportunities do you see ahead?
With developed markets now more broadly in recovery, we began to shift our overweight in emerging markets back into European and Japanese equity markets last year – a trend we expect to continue in early 2014.
Not all emerging markets are the same, however. In Asia we favour countries that are commodity importers with stable current accounts and positive earnings growth.We also prefer active managers in emerging markets where stock selection makes a tremendous difference for performance.
Q: How long do you foresee the window of opportunity lasting?
We told clients at the start of last year that 2013 was a year of rational exuberance and not to be out of markets. We feel the same about investing in markets this year. But we are keeping a close eye on valuation as, unlike last year, there is nothing obviously cheap across markets. Markets aren’t over-extended with regard to valuation, but they now have to justify the fact that the majority of returns last year were driven by multiple expansion. We need to see both top-line and earnings growth this year across equity markets. This year is likely to define how much further markets can run ahead. With global growth more balanced and investor exuberance still tempered, this part of the recovery cycle can run well into 2015 – with lower returns. However, if markets actually become over-extended, we may be pulling back on certain investment opportunities later this year, in favour of markets worth revisiting.