The outbreak of Covid-19 has led to the focus of everyone’s thoughts being on getting through the next few weeks and months until any semblance of normality returns, writes John Husselbee. As investors, however, we need to look ahead as far as possible...
We have written in recent weeks that while coronavirus is exacting a huge toll on people, the world will come through it and current depressed valuations in certain parts of the market are offering potentially attractive entry points for investors prepared to be patient.
With this in mind, we are among many asset allocators reviewing our positioning and working out how we want portfolios to look heading into a new cycle. Our tactical asset allocation can range from one to five, with one the most bearish and five the most positive, and we have been neutral since 2018.
While the speed of recent events meant we were unable to move down the scale, we now see an opportunity to take advantage of cheap equity valuations as we move up to five, looking to be on the right side of the buy low, sell high maxim.
No one will need reminding that recent events have brought a swift end to an 11-year bull period but, as markets start to recover, what will drive performance - and, importantly, will it be the same as the factors that dominated the recent run?
Looking at what has worked over the last five years, there are some clear trends in evidence and any portfolios getting these right will have comfortably outperformed. In equities, for example, the US has substantially outperformed other markets around the world, including the supposedly higher risk (and potentially higher reward) emerging markets.
Another pronounced trend has been growth stocks outperforming value. Again, despite intermittent spikes in value and proclamations of an impending turn in fortunes, growth companies have produced more than three times the return over five years.
A third factor is large-cap companies outperforming small, and a corollary of this has been passive funds broadly beating active, with the latter typically focusing on the mid and small end of the market. The magnitude of this outperformance by large caps is more than double over five years to the end of March.
If these are the short to medium-term trends that have driven performance for the last five years, what can we extrapolate from this? What is immediately apparent is that all three run contrary to longer-term trends.
If we look at 20-year charts, the US has still outperformed the MSCI World Index - consider that the 11-year bull run took up over half the period - but emerging markets are far ahead, registering a dollar return of more than 380% against 210% by developed markets.
We can also see similar reversals over longer timeframes for value and small caps. Providing some much-needed succour for value advocates, this style has outperformed growth over the last 20 years, although, given the level of underperformance for such an extended period of time, the two are not that far apart in returns.
With smaller companies, the traditional outperformance over larger names is much clearer over 20 years: again in US dollars, small caps are up around 320% versus 120% for larger companies.
As asset allocators, our decision making at this point rests largely on whether we see the last five years as cyclical or secular: have conditions changed to favour these dominant factors in the future or will longer-term trends reassert themselves?
We could write a whole series of articles on this, and there are obvious questions to ask, particularly when we all finally emerge from the coronavirus lockdown. How much will globalisation reverse for example and can technology continue to disrupt industries to the same extent as it has over the last decade or so?
It could be argued that the rise of the FAANGs (Facebook, Amazon, Apple, Netflix and Google) has been behind all three of our equity trends - growth, large cap and US - and whether they can remain so dominant will be a key talking point with our underlying fund managers for the foreseeable future.
For our part, we remain in the longer-term trends reasserting camp. Our portfolios have been underweight US and overweight emerging markets and tilted towards value and smaller companies, and we would expect to maintain this profile as we dial up our risk over the weeks and months ahead.
John Husselbee is head of multi-asset at Liontrust
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