Last updated: 08:46 / Thursday, 21 July 2016
According to Investec

The Need For Portfolio Resilience

The Need For Portfolio Resilience
  • We need to continue to be selective in emerging markets
  • A bottom-up approach to choosing investments can help penetrate the short-term macroeconomic noise
  • The environment has become marginally less supportive for stock picking

At the end of 2015, investors were confronted by a world that appeared to be full of potential pitfalls. To preserve and grow the value of their assets, they needed robust portfolios that could outperform the market in challenging environments and deliver resilient returns in the face of unforeseen events.

The investment environment in 2016 has been no easier. A slowing Chinese economy, the Bank of Japan's surprise move to introduce negative interest rates, political and economic uncertainty in the US and the UK’s momentous decision to leave the European Union have all played their part in increasing global financial instability and volatility.

Investec’s approach to building portfolios that are resilient in the face of such tumultuous events requires a strong understanding of investment risks, beyond estimates of volatility. For them, portfolio construction should balance the trade-offs between potential returns and individual assets’ contribution to overall risk exposure. But also they need to be diversified and to avoid those parts of the market that could be vulnerable to sudden liquidity squeezes. According to them, investors should also have strategies to cope with periods of market stress.

Diverging monetary policies
Six months ago, they believed the US dollar would reach new cyclical highs, as US monetary policy slowly normalized. Then, Europe had only just started to run down private-sector debt and seemed at least three years behind the US. Asia, and China in particular, were further behind Europe. These markets’ debt to gross domestic product ratio were still high, suggesting that monetary easing would need to continue for several years.

Since then, global economic headwinds and a weaker domestic backdrop has prompted a more dovish tone from the US Federal Reserve in the first quarter of 2016, which has slowed the pace of monetary policy normalization. “This means that the phenomenon of diverging monetary policy is less pronounced than it was at the beginning of the year.”

Selectivity needed in emerging markets
“Our belief that the emerging market universe is disparate, and offers a wide range of investment opportunities still holds true. We continue to favour economies that are natural extensions of developed markets, such as Hungary or Romania are for the European Union. Nevertheless, we believe we need to continue to be selective in emerging markets, partly due to different sensitivities to demand for Chinese commodities and the US dollar.” They note.

Finding bottom-up opportunities
“We continue to believe that a bottom-up approach to choosing investments can help penetrate the short-term macroeconomic noise. Emerging market equities and resource stocks led global stock markets higher from mid-January, at a time when Chinese data remained negative and many analysts were forecasting a US recession. However, we still acknowledge that the environment has, even if temporarily, become marginally less supportive for stock picking.”

ESG going mainstream
Investec’s experts believe that 2016 is when many investors will be focused on taking account of environmental, social and governance (ESG) issues. Integrating ESG assessment into investment processes is increasingly being seen as a way of driving long-term value creation. “German auto manufacturer Volkswagen could be seen as a game changer triggering increased attention on corporate behavior and practices. The Paris Agreement on Climate Change in December 2015 has also focused investors’ minds on the environmental challenges surrounding global warming.” They conclude