Bambos Hambi, head of multi-manager at Gartmore, explains the importance of well-researched asset allocation
I BELIEVE THE most successful multimanager funds are built on two key strengths, the team's ability to select the best funds that the market has to offer, and its skill in assessing which areas of the investment universe offer the most attractive opportunities.
Making the correct asset allocation calls can really add value for investors, but if you get it wrong the negative impact can more than outweigh the benefits of astute fund selection.
Fund selection and asset allocation are two separate but complementary skill-sets and it's important to know where your team's main strengths lie and recognise your limitations.
At Gartmore, our team's primary expertise is choosing the right funds and portfolio construction, so this is where we focus our energy.
Asset allocation is handled separately; it's 'in-sourced' to Peter Gale, Gartmore's head of private equity.
The team meets with Peter on a monthly basis, with ad-hoc meetings when appropriate, to discuss his medium to long-term investment views.
These are formed through fundamental research and independent interpretation/ analysis of market data.
Markets are inclined to overreact to news or events, and generally take a short-term view.
Because of this focus on short-term movements and the risk of underperformance, the wider market tends to overlook the bigger picture and miss out on some attractive investment opportunities.
By taking a longer-term view of the economic cycle, market valuations and structural drivers, such as government policies or changing demographics, we believe we can select the asset classes, and regions, that will deliver superior risk-adjusted returns.
Our funds' broad investment remit means our asset allocation process assesses the relative merits of equities (including regional and sector stances), bonds (where we evaluate sovereign, credit and high yield possibilities), as well as cash and property markets.
The team takes a holistic approach to risk.
We interpret Peter's views according to his level of conviction and the existing balance of risk within the portfolio.
Relative valuations currently lead us to favour equities over bonds, where Gartmore's Portfolio range is underweight at the moment.
Where we have retained bond exposure within our portfolios, we are defensive in our positioning.
While we acknowledge that bonds can at times offer a comparative refuge, our view is that the current risk/reward profile is unattractive and investors are not being adequately compensated for future risks.
Aligned to our underweight position in bonds, and a marginal overweight in equities, is an overweight cash position and a neutral stance towards commercial property.
Within equities, we prefer the UK, Europe and Japan, as these markets offer attractive relative valuations.
Meanwhile comparatively higher equity prices and weaker fundamentals have led us to adopt a cautious view of US equities.
We favour UK equities as we believe this typically defensive market is likely to prove more resilient if the current environment of slowing global growth persists.
Also, unless we see significant downgrades in companies' earnings expectations, valuations look reasonable.
The valuations of European equities, which we believe reflect a pessimistic outlook for the region, also look attractive.
While we believe that gross domestic product growth will continue to slow, expectations are already low and this can be seen in equity prices.
However, with companies increasingly focused on delivering returns to shareholders, and corporate restructuring underway across the Continent, we feel the region's markets are well supported.
Our positive view of the Japanese equity market is also supported by this restructuring theme, which is particularly prevalent among domestically-exposed companies.
Elsewhere, we are slightly overweight in Asia, and to a lesser extent, emerging markets.
The fundamentals in both regions appear relatively strong, as reliance on export-led growth is less marked than in previous economic cycles and domestic growth seems generally positive.
Therefore we believe a slowing global economy will have a reduced impact, with buoyant demand from China and India supporting these markets.
Meanwhile, our negative view of the US equity market is founded on a combination of structural, fundamental and valuation concerns.
We feel that slower consumption is inevitable as interest rates continue to climb, debt (both secured and unsecured) is a significant issue, and the housing market is in the latter stages of the current cycle.
The current account deficit and trade deficit also pose a threat to both the US dollar and the equity market.
As well as our regional view of equity markets, our asset allocation philosophy and process also enables us to adopt a sector-specific approach to equities where relevant.
Currently, we are cautious in our approach to commodities.
We believe the on-going tightening in US monetary policy is likely to cool global economic growth, which in turn leads us to expect some price weakness in commodities.
Larger names in the sector have already begun to experience this and as we see evidence of increasing production combined with declining demand, we expect this to continue.
Our overweight position in cash is supported by our view that the risk/reward balance is currently more favourable than that of bonds.
Within the currency markets, we hold a negative view of the US dollar.
US interest rates continue to follow the anticipated pattern of measured increases as the ongoing strength of the domestic housing market, which supports further spending by the indebted American consumer, has helped the economy consistently match or exceed expectations.
Nonetheless, we believe rates will have to rise in order to encourage saving and discourage spending.
The weakness of the dollar may have troughed, but we anticipate that the economy will slow further while rates continue to rise.
Meanwhile, as evidence of slower economic growth in the UK increases, we believe that interest rates have now peaked.
It is clear that we are at the top of the interest rate cycle and as data paints a less rosy picture, we feel it is reasonable to expect one or two rate cuts of 25bp.
Our analysis of property investment fundamentals leads us to believe that we are now at the mature stage of the current property cycle.
However, this does not necessarily mean we anticipate negative returns for the rest of 2005, or next year for that matter.
Current demand remains both too strong and too diverse to necessitate an immediate de-rating.
However, our view recognises that yields, which have already compressed significantly, will not do so indefinitely.
On a more positive note, most measures of rental growth indicate an improving trend, which if sustained, should provide some support for the market.
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