Pump up your portfolio

The global financial crisis and subsequent recession has had a devastating impact on the world’s economy. Wealth preservation has become the overriding priority for many investors and their advisers, and there is a growing recognition managing assets and consistently delivering benchmark, or better, returns is a very difficult and extremely challenging task.  The mindset of many high-net-worth investors has become much more cautious, particularly those financing their retirement off a fixed asset base. The wealth management industry has had to adapt to the greater uncertainties in the world, particularly in terms of where and how to deploy risk capital on behalf of clients. One approach to portfolio construction adopted to accommodate these uncertainties, as well as meet the cautious mindset described, is that of ‘bar-belling’. This is a process where portfolios are purposely over weighted at the low-risk end of the risk spectrum, such as cash and bonds, and smaller, targeted allocations made to high-risk assets – such as emerging market equities and commodities. 

It is clear improving economic data has recently increased the appetite of investors to take on more risk but many agree the outlook remains opaque and the need for diligence and vigilance must remain at the forefront of their minds. For managers, the need to continually assess and monitor macroeconomic conditions, sentiment, momentum and fundamentals is now, more than ever, essential if they are to achieve attractive risk adjusted returns.

At the macroeconomic level, there are five key issues which, for many, remain strong ‘headwinds’ that the developed-world economies must overcome before a sustained recovery can be achieved:    

1. Consumer deleveraging - the over indebtedness of the Western consumer is too high compared to household incomes and credit availability, particularly in the US and the UK.  As much as consumers, investors, bankers and politicians may want to return to ‘business as usual’, the fact is the Western economies are dramatically changed.  Consumers approached the crisis period with extremely low savings and high indebtedness.  As a result, unemployment quickly translated into defaults on consumer loans and a decrease in consumer spending.  Data from the Federal Reserve showed that consumer credit declined by $21.6bn in July, or 0.9%, the biggest drop in percentage terms since 1975 and more than double analysts' expectations.  With consumer spending accounting for 70% of US GDP, the impact of consumer deleveraging and high unemployment rates means consumer demand is likely to fall short of the level  markets have priced in.

2. A weak banking sector - the banking sector in the developed world remains weakened by the financial crisis and asset quality has deteriorated as the household and corporate sectors struggle to service debt.  The International Monetary Fund (IMF) recently published its Global Financial Stability Report and while it commented the state of the real economy was improving, banks ‘remain under strain’ and it restated its view that the global banking sector losses would still reach US$2.8 trillion. For the first half of 2009, circa US$1.3 trillion of write-downs have been reported, suggesting we are only half way through the necessary unwind. In other words, if the IMF is correct, significant write-offs still remain to be taken within the banking system. Additionally, banks are already considered under-capitalised in the light of pending regulatory reform and this will limit their ability, and appetite, to lend. The flow of credit through economies will continue to be restricted and this does not augur well for a robust, sustainable economic recovery.  

3. Public sector weakness - the governments of the Western world have amassed enormous debts as a price for the substantial stimulus packages introduced.  The UK has more than doubled its public debt in the first half of 2009 to a record high of £77.3 billion, and the government has voted to increase its expansion by £25 billion to £200 billion, far more than the Chancellor's £175 billion forecast. Logic would dictate that public spending must be curtailed and taxes raised, draining consumer-spending power still further.  We are likely to see benefits cut for retirees younger than 70 years old, or for high-net-worth individuals, they may well be taken away. In terms of financing and servicing the national debt, a further complication is that many foreign holders of UK debt are investing more in their own economies, which means the demand for gilts will diminish and, in time, increase interest rates thus slowing the economy.

4. Corporate capital expenditure cuts – a recent survey in the US revealed that 79% of CEOs questioned expect capital expenditure to be flat or down over the next six months. Management teams are not confident about the strength of the recovery (see consumer demand above) and top-line sales growth is difficult to capture.

5. Policy risks – the IMF believes it is too early to withdraw official support policies, but a strategy for disengagement is needed. As speculation grows to when policy changes will be announced, we are almost certainly likely to see higher bond and currency volatility, rising bond yields, and inflation concerns grow. The likelihood of perfectly timing the reversal of this unprecedented support is remote and confidence in the economic recovery will be very vulnerable to ill-judged policy mistakes.

At Fairbairn Private Bank the ‘bar-bell’ approach to asset allocation and portfolio construction remains our favoured style as we believe it meets our current assessment of the global risks but also allows us to capture investment returns as economic leadership moves from the developed world to the East.  With interest rates at an all-time low around the world, and with the outlook that this environment will prevail for some time to come, the quest to preserve capital but still achieve investment returns ahead of cash is the number one priority for investors. Our wealth management service is purposely designed to offer the opportunity to capture enhanced returns above cash, with the target level of return dictated by the level of risk a client is prepared to take.

If our wealth management service appeals to you, and you have a minimum of £100,000 to invest, please call us on +44 (0) 1624 645000.

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