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.