What Will 2014 Bring for Investors?

What will 2014 bring for investors?

Another highly volatile year for investments has just come to an end with a bit of ‘icing on the cake’ for the final two weeks of the year as investors suddenly realise that tapering of Quantitative Easing (QE) in the US is not all bad news. It could be interpreted that taking the ‘security blanket’ away might be because the US Economy is now capable of standing on its own two feet. Looking at recent economic data coming out of the US and all other major economies it does seem that we have ‘turned the corner’ and investors can now settle down to Markets that should be far less volatile than experienced over the last five years. This is not to say the issues faced over the last five years have been eradicated as all will still play a key part during 2014. However these issues are now in a position where they can be controlled and, as such, will not damage the positive growth prospects emerging from the global economy.

As we are starting a new year I thought it would be a good time to take a closer look at all asset classes and give investors an indication of how I see the asset allocation of portfolios panning out during 2014.

1. Cash- As we heard recently from the FOMC meeting in the US, interest rates in the US will remain at the current levels until at least the middle of 2015. Europe, with the recent reduction in rates, seems to be in the same position as the US with the UK being the only westernised economy that could raise interest rates in 2014. This is not a foregone conclusion with mixed messages coming from the Monetary Policy Committee (MPC) on whether the recovery in the UK is in a position to accept a rate increase during 2014 or will the current position need to be held until 2015 as in the US. The only positive point about cash at present is that ‘Inflation’ remains under control so investors using cash will not have growth negated by inflationary pressures. For our portfolios cash remains a vehicle to pay charges and, except for the longer term pension policies, we will not be looking to utilise cash within our asset allocation during 2014.

1. UK Gilts and Sovereign Debt- This is an area under significant pressure at the moment with a number of negatives affecting the price and subsequent return. We have seen UK 10 year yields increase to 2.97, a 120 basis point rise in the last year. Despite the indecision on potential increases in interest rates in both the UK and US, this increase in yields across all elements of the Gilt curve has had a significant impact on both price and return. We will continue to hold a small amount of sovereign debt in portfolios going into 2014 however, this is for diversification purposes only and will continue to be on a ‘short duration' basis only. Later in 2014 it may prove time to look at longer duration opportunities but this will only be for Pension Investments were we know we can benefit over the longer term investment timeline.
2. Index Linked Sovereign Debt- As indicated above, inflation does seem to be fairly dormant at the moment. We feel that during 2014 inflationary pressures will start to show in both the US and UK however Europe will continue to show deflationary tendencies as the Eurozone shows similarities to the Japanese economy back in 1995. I do not feel that Europe will experience the same problems that Japan has done over the last 20 years as they have taken steps to improve and soften monetary policy albeit at a lot slower pace than the US and UK. Despite the lack of inflationary pressure, which we feel will continue into Quarter One of 2014 both in the UK and US, we do see an opportunity with Inflation linked bonds at some stage during 2014. They will remain to add diversification and to provide some growth opportunity at some stage. One area of Inflation linked investment that we are considering for portfolios early into 2014 is that supporting the other areas of the Global Economy such as the BRIC states and other Emerging markets. Countries like India, Brazil and China are seeing quite aggressive inflation at present and with no sign of monetary policy hardening in these areas, due to the fragile state of their economies, this could be a good area to get growth via Inflation linked opportunities.

1. Corporate Bonds- This is the most difficult of the bond sectors to call. With the improving economic picture corporate bonds should be a good area for growth in the bond market. With the extremely low levels of yields experienced in the whole of the bond market through 2011, 2012 and early part of 2013 the corporate bond sector, like the Sovereign bond sector, is seeing yields starting to move back to normality and this will continue during 2014. On a positive note, over the last 12 months default levels have fallen back to historically low levels and there is far more opportunity from the financial sector especially via the Banks were the ‘new breed’ of bank debt Coco’s (Convertible Contingent notes) are becoming very popular with the specialized Bond Investment Houses. It is with these providers that I will be seeking to place a decent proportion of fixed interest content during 2014.

1. High Yield Bonds- ‘Risk On’ will be an important element for 2014 and therefore we will be looking far more closely at the high yielding sector of the bond market as we move into 2014. As confirmed above, with historically low default levels High Yielding Bond Managers can now utilise a larger amount of lower grade debt in the knowledge that the purchased bond will provide the additional yield without the threat of default, thereby effectively taking away the additional ‘risk premium’ they are paying for the bond. We will not just be focusing on the UK in this area. We have successfully utilised the opportunities that Europe gives us over the last couple of years and with global sovereign bonds under a lot of pressure global high yield seems to be a sensible place to provide the additional diversification that is needed for investors, certainly in the area of Fixed Interest.

1. Property- 2013 was a very good year for both Commercial Bricks and Mortar funds and the Global property REITS sector. To focus on the UK Bricks and Mortar sector first, it was the first year that a number of Fund Managers have indicated that over 95% of the properties in their portfolios have tenants with a couple (for example the Henderson fund) declaring 100% occupancy for the last quarter of 2013. This offers stability for the Manager as well as the increased yields. However, most Managers in this sector have indicated that the opportunity to purchase new quality property opportunities is very limited so many are sitting on larger ‘cash holdings’ than they would like. Also where the properties are tenanted the opportunity to increase rents is very limited because of the position of most businesses in the current economic cycle. This area, though, is one that we can look to develop for the portfolios in 2014 in the knowledge that we are not increasing risk if we start to reduce our bond content through the early part of 2014.

In the Global REIT sector it was a very good year for those investors in the higher risk categories where we have utilised this sector alongside the UK Bricks and Mortar sector. We started the year investing in Asia and when we saw the bubble starting to burst we moved into Europe and in both areas we experienced exceptional returns. We will continue to utilise this sector in Europe/UK initially however, at the end of 2013 we saw tighter monetary policy in most Asian countries, especially in China, so a move back into Asia could be a likely scenario sometime during 2014.

1. UK Equities- From the doom and gloom rhetoric of Mervyn King in February/March 2013 regarding a possible ‘triple dip recession’ in the UK, the economy has shown just how resilient it can be with it now being the leading economy in Europe. As with most recessions experienced in the past the sector that provides the best opportunity for investors as the economic cycle starts to turn to positive is that of the smaller companies sector. In the last five years the top performing fund sectors are all smaller company related with the UK smaller companies sector being the top performer with an average fund return of over 200%. Recently a number of commentators have indicated that they see this sector falling back in 2014 with more defensive stocks coming to the fore. We do not agree with this as we see 2014 being another year where smaller companies will provide an excellent return. The reason for this is the volume of Mergers & Aquisitions (M&A) activity that is starting to show in this area. Growth over the past 5 years has come from ‘price’ with a small amount of M&A activity. In 2014 we believe the growth will be driven from M&A with 'price' taking a back seat. This we will not produce the exaggerated returns we have seen recently but more ‘sedate’ growth from this sector. This will reduce the ‘risk’ for investors and provide a more sustainable opportunity. Effectively, the portfolios in this area will be the same as they have been over the last two years with both the Growth and Income funds coming from either an unconstrained fund manager or directly from the small or micro cap sector. The one thing you will not see in the portfolios is a ‘proxy bond fund’ which, in the ‘Income sector’ especially, have taken far too much money. They are effectively ‘treading water’ as they are full of defensive stocks where dividends are either under pressure or only yielding what you will receive from buying a bond with the same company - not what I would call a good deal for investors looking for equity returns.

1. US- Very similar position to the UK where the main opportunity for growth has come from the smaller companies sector. The main threat to the US is coming from the PE ratios where a lot of companies are now trading at PE over 18 and some even higher, trading in excess of 20. This limits the growth in the Dividend opportunity from US companies with most seeing a hold in Dividend yields during 2014 or even a small reduction. On a positive note tapering, which comes into effect in January 2014, has not affected the equity markets as many commentators thought it might following the falls in markets from the end of November up to the FOMC meeting on the 18th December 2013. Effectively, those falls have been reversed with markets back to pre-tapering announcements which first came out in May 2013. Also, with the recent signing of the ‘Cross Party Budget deal’ by Barrack Obama the threat of another Government shutdown has been averted and signs are very good that the cross party group, set up to deal with all budget decisions, will secure a deal to cover the US Debt Ceiling that is due for a review on 7th February 2014. With regards to the portfolios, the US equity content will continue unchanged with Bio-Tech and Smaller Companies sectors the preferred areas for investment.

1. Europe- This is the area that I feel offers investors the ‘best value’. Unlike the US and UK were PE Ratios are in the high teens/early twenties, the PE ratios in Europe are still very attractive with most companies at the lower teens level. This price reflects were Europe presently sits in terms of it's economic cycle, probably eight to ten months behind the UK and US. Therefore we will be looking at Europe a lot more in 2014 with both the defensive position and smaller companies sector forming part of our equity proposition for investors. To add to the positive feel of this review, with the recent inauguration of Angela Merkel as German chancellor for a further term in office there has been a real change in the ‘hard line attitude’ that was shown by her, and her party, in the early stages of the Eurozone crisis. Clearly Europe is not ‘out of the woods’ yet however, the far softer rhetoric coming from Angela Merkel and her senior aids on the softening of monetary policy in Europe gives real hope that Europe will not end up in the same position as Japan with years of deflation, aggressive currency values and very low growth.

1. Japan- Currently this area provides most of our workload in the Investment Services team. The new term ‘Abeonomics’, first used in 2013, has certainly kept us on our toes in both understanding what Japan are looking to achieve as well as some of the timings of the decisions. At this stage the ‘jury is out’ on whether Japan will enter a significant period of positive economic data. Inflation remains stubbornly low and the Yen continues to be relatively strong against all other currencies. The one area of hope is that there seems to be further scope for more Quantitative Easing (QE), despite the fact that Japan has had more QE in the last 12 months than the US as had in the last three years. With this in mind we are looking to make a small change to our policy on Japan. We will be looking at a change in funds with the current aggressively positioned Legg Mason being removed from the portfolios and replaced with a more defensively placed Fund.

1. Emerging Markets- This could be a similar situation to Japan at the end of 2012 when I composed my overview at the end of December 2012 and called Japan “the basket case of all basket cases” only to end up with Japan in the Bespoke portfolios a month later! I am not intimating that the Emerging Markets are a ‘basket case’ however, at this point in time, I cannot see when I will be looking to get any form of Emerging Market equity content back into the portfolios. All four BRIC states have their individual economic difficulties and despite the global markets reacting very positively to the news regarding tapering in the US, the one area that will suffer is the emerging markets. This is mainly due to the reliance that many emerging market economies have on the US Markets and any sign that consumer spending in the US may come under pressure will hit these economies (as we saw in May 2013 when the use of tapering was first proposed by Ben Bernanke). There are a few positives showing in these emerging markets so we shall keep this area very much in focus during 2014. Firstly, I believe the ‘sell off’ since the end of May has been far too heavy and there are a lot of cheap valuations in some of these economies. Secondly, there are real signs that the Chinese Economy is ‘turning a corner’ and when some of the softening of their monetary policy starts to ‘kick in’ during the early part of 2014 it is likely that quite a healthy economy will emerge. It is not expected to produce the growth at 2008/2009 rates of 12%-13%, but a GDP figure that is likely to rise quarter by quarter so look out for China entering the portfolios at some stage end of Quarter One/ start of Quarter Two. Third, and most importantly, the size of this market place makes its very hard to exclude. There are 56 economies that make up this sector and of those 56 most are good quality economies. Despite the recent ‘sell off’ most do have a lot to offer investors over the next three to five years so, with it's size alone, I cannot see emerging markets being out of the portfolios for too long.

1. Alternative Investment Areas- There will be a lot of Structured Deposits ‘Kicking out’ or maturing over the next couple of years so the options to continue investing in these areas is focusing our minds at present. Recently we have seen little in this space that enthuses us especially in the deposit area where we feel the coupons are not reflecting the opportunity that is available at this time. With interest rates likely to remain very low we believe structured product providers need to become a bit more inventive in their product opportunities and, in particular, the coupons that they pay. Currently we are speaking to the a number of providers in this regard so it will be interesting to see how they react. It not just FAC Ltd that has stopped using structured investments as the inflow of monies to providers is down by one third compared to this time last year indicating that other advising firms feel the same way. On a positive note, they do offer us more diversification especially via the deposit investments and they could be used as a direct replacement for gilt and bond monies. Like emerging markets it is very much ‘watch this space’.

With regard to the other alternative areas (daily priced opportunities) we have used a couple of funds to reasonable effect during 2013. The Odey fund has been held in portfolios for the last 16 months and has had a fabulous year with a return of 45% in the last 12 months. This fund is quite aggressively charged but whilst it continues to perform it will certainly stay in the portfolios as it offers advisers and investors additional diversification that we believe will be necessary in 2014 to keep portfolios moving forward. In terms of other funds the ‘Absolute Return’ sector is the fastest growing of all the IMA Sectors so we will certainly see new opportunities come available during 2014 and beyond. If they will add something different and have an opportunity to provide a return we will use them.