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Liquidity to take advantage of volatility says Heartwood

Liquidity to take advantage of volatility says Heartwood

By David Absolon, Investment Director at Heartwood Investment Management

The year has started on a positive note, which has not just been driven by revised expectations of US growth but also broader improvements in global manufacturing surveys and confidence indicators. In developed economies, labour markets remain supportive of future consumption and we expect corporate profitability to improve in a slightly more reflationary environment. Rising confidence has been reflected in positive financial market performance since the US election. However, fundamental change, if any, takes time and as expectations have raced ahead of reality there is the potential for disappointment in the short term. We expect any pullback to be a pause rather than anything more serious. Policy uncertainty – whether driven by Trump, Brexit or national elections in Europe – will continue to aggravate markets and may potentially be a source of disruption.

Overall, we believe that global growth will be stronger in 2017 and this should support investor appetite. However, acknowledging that underlying risks do not suddenly disappear, we are also retaining reasonable levels of liquidity to take advantage of periods of volatility as they inevitably occur. Although sterling has seen meaningful weakness, we are not yet ready to bring money back into the UK and retain our preference for other developed economies. We continue to believe in the longer term investment case for emerging markets, but expect in the near term it will remain vulnerable to US policy risks. We are becoming more positive on specific hedge fund opportunities, given the greater likelihood of increased stock dispersion (i.e. between winners and losers), as well as credit long/short strategies.

Equities: Having gone overweight overall post the Trump win, there is no desire to add further to equity positioning at present. Markets have given back some gains recently, but we expect this to be a pause rather than anything more serious. The improved growth picture is supportive, and the start of earnings season has so far been encouraging. We are holding a greater exposure to US equities than we have had for some time. We maintain overweight positions in the cyclical markets of Europe and Japan, which represent attractive value on a relative basis and are expected to benefit from a corporate earnings recovery. We continue to underweight the UK, but expect to be rebuilding exposure in the medium term. We are not yet ready to add to our emerging markets exposure, given vulnerability to headwinds in the near term. However, we remain optimistic on a longer term view and would use any weakness as an opportunity to add.

Bonds: We are maintaining our long-standing short duration position to reflect gradual reflation and the shifting bias of some central banks towards a more balanced tone. The US Federal Reserve is very slowly normalising interest rates and the European Central Bank will scale back its asset purchase programme this year. If yields rise to a meaningful degree, we may take the opportunity to extend duration as our shorter-dated bonds mature. We have also sold our US High Yield energy position following strong performance and expect to recycle assets into the broader high yield market to take advantage of potentially higher US growth. We are maintaining our modest allocation to emerging market sovereign debt (hard currency), given our expectations that the asset class should benefit from cyclical and structural economic improvements.

Property: We remain underweight in UK commercial property on concerns around supply, especially in the South East, and uncertainties around Brexit. Our portfolios are invested in diversified and select parts of the market. Across sectors, we continue to seek income opportunities in the industrials and offices. On a regional basis, we are invested in cities outside of London, which are less exposed to the ‘Brexit’ fallout. Outside of the UK, we are also looking at opportunities in the US REIT (real estate investment trust) market, where valuations have cheapened but are not yet compelling.

Commodities: An improving global economic environment, reflation and a tighter supply/demand balance leads us to hold a more positive view on commodities in 2017, particularly for oil and base metals. Direct access to this market is through owning futures contracts rather than the physical assets and while the risk/return profiles are looking more attractive across some parts of the complex, they are not yet at levels where we are ready to invest. We have also bought gold in some strategies as a portfolio diversifier.

Hedge funds: While we have held a limited allocation to hedge funds in recent years on concerns around performance, we believe that a shifting economic climate should create more opportunities in this sector in 2017. Our preference remains for macro/CTA strategies, but we are also taking a more positive view on equity hedge strategies, given the greater likelihood of increased stock dispersion (i.e. between winners and losers), as well as credit long/short strategies.

Cash: We have reasonable levels of liquidity across our portfolios both in cash and short-dated bonds, which we are ready to invest as and when we see specific opportunities.

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