The high returns that investors could receive pre-financial crisis without having to take as much risk will not be available for the foreseeable future.
That said, there are opportunities for investors that can look beyond the headlines and concerns of the immediate future to adopt a disciplined approach, set realistic goals, and be willing to be opportunistic in realising their long-term objectives.
For example, with all the talk about the macro-economic and political situation of the eurozone, much of Europe Inc. remains fundamentally strong. GDP growth may be sluggish, but the European corporate sector includes a wealth of world-class, global corporations which generate only half of aggregate revenues in Europe. Corporate Europe is more dependent on emerging markets and the US for growth than on its domestic economy. Furthermore, balance sheets are generally robust, with companies, unlike their governments, having taken advantage of the financial crisis to clean up their financial house.
We continue to emphasise the theme of “resilient equities”, which can be found across the Continent and exist in different sectors, from healthcare to industrials. These companies operate in industries with high barriers to entry, enjoy superior pricing power, have a high percentage of recurring sales, are exposed to fast-growing regions or sectors and have a high-quality balance sheet.
Looking further afield, while the growth potential of the emerging markets is not a new phenomenon, we are at an inflection point. The IMF estimates that 2013 will be the first year we see the total GDP of emerging nations exceeding that of advanced economies and, given the current challenges facing the developed world, we expect the growth gap will only continue to expand. Risk aversion and deleveraging by international investors has made equity valuations cheap compared with historical averages, and we expect that recent underperformance may be coming to an end.
We expect Asia (excluding Japan) to attract most funds flows, followed by Latin America, emerging Europe and Africa. As the largest regional group within emerging markets, Asia offers more liquidity for foreign investors and potentially stronger currencies. In Latin America, interventionist policies from some governments may impose a risk premium to asset prices, while emerging Europe may remain in the shadow of its deleveraging neighbour.
Risk premiums declined in fixed income markets around the globe last year, making defensive positioning important. Emphasis on shorter maturities, favourably mispriced sectors, selective credits and ample liquidity should allow investors to extract the best possible risk-adjusted returns from what is offered today, while providing the flexibility to reposition the portfolio when better opportunities present themselves. Being active and remaining nimble is key to navigating what promises to be a more nuanced fixed-income environment this year.
There are just a few examples of areas of opportunity, but this should not detract from the importance of tailoring a diversified portfolio to investors’ specific objectives. Risk requires a personal definition to capture how much can be tolerated and how liquid a portfolio the investor wishes to maintain. Investors then need to be realistic about return and yield expectations. In many cases, investors need to face unpalatable truths and recalibrate their expectations of what they might achieve over time without dramatically going beyond their risk tolerance. Finally, it is more important than ever for investors to actively review the state of their portfolios with their advisers to avoid inertia and ensure that chosen exposures remain relevant to their goals.
