How to invest in a late-stage bull market
With an ageing bull market, rates at unusually low levels for this stage of the cycle, and rising geopolitical uncertainty, investors couldn’t be blamed for wanting to cash in their chips and run. But all these factors were true two years ago too, and the ASX 300 Accumulation Index (which includes dividends) has gained nearly 24% since then. The fact is that there will always be uncertainties in the market and reasons to worry, but without any insight as to the timing of a crash or recession, investors must position for a range of possible outcomes.
With so much noise recently on the topics of trade wars and bond yields, I decided to reach out to three leading asset allocation specialists to get their take on how they’re investing for the current conditions. Responses come from Tracey McNaughton, Head of Asset Allocation at Wilsons Advisory; Andrew McAuley, Chief Investment Officer of Credit Suisse Private Bank Australia; and Rob Holder, Head of Asset Allocation at Crestone Wealth Management.
The wisdom of age
Tracey McNaughton, Wilsons Advisory
The US equity bull market is now ten years of age. With age comes wisdom. Unfortunately, age also brings risk and in market years, a decade is considered old age. We have adjusted our asset allocation to reflect this late stage of the investment cycle in four key ways:
Increased diversity in the portfolio
Events and how the market and policy makers will respond can become more binary in the later stages of the cycle. Under these circumstances, it pays for investors to be as diversified as possible. We have recently increased our allocation to Australian bonds, unlisted infrastructure and private debt.
Associated with the rise in uncertainty, late cycle investing also tends to come with higher market volatility. We have increased our allocation to funds and instruments that specifically minimise volatility. In particular, we have increased our weight to Alliance Bernstein’s Managed Volatility Equities Fund and introduced a new ETF into our international equities portfolio called the iShares Edge MSCI World Minimum Volatility ETF. In this environment, where binary outcomes are becoming more prevalent, it is important to narrow the range of possible performance outcomes.
Manage your liquidity
When volatility rises, liquidity can dry up quickly. We are ensuring our position size in Alternatives is kept small in relation to other, more liquid, asset classes. Our fixed income portfolio is heavily weighted toward more liquid parts of the bond market such as government bonds and investment grade credit. We like high yield credit but are keeping the weight relatively small.
As the investment cycle progresses, the probability of a tail risk event rises. We have increased our allocation to gold given it increases portfolio diversification and acts as a tail risk hedge.
Choosing to lock in profits
Andrew McAuley, Credit Suisse Private Bank
We have been overweight equities this year which has been a good contributor to performance. However, after having a strong run, valuations on a price to earnings (PE) multiple basis are about 10% expensive relative to the average historical PE. We recognise valuation versus the 10-year bond yield remains attractive but have chosen to lock in some profits.
Having reduced equities to neutral in our discretionary and advisory portfolios, for several reasons, we are not inclined to take further risk off the table for now:
- The impact of tariffs themselves on the global economy is manageable.
- We are confident actions by the Chinese Government and PBOC to stimulate their economy will work, and there are some signs of stabilisation.
- Should the US and global economy unexpectedly deteriorate further, the Fed and other central banks stand ready to ease.
- We continue to believe that President Trump will want to de-escalate the trade war as the 2020 election nears.
We maintain a full allocation to bonds and have added longer duration government credits which will do well if 10-year yields continue to fall. The RBA has clearly indicated further rate cuts and even some form of quantitative easing (QE) is on the table which will continue to put downward pressure on yields.
Within International Equities the US is our most favoured region given GDP growth is a reasonable 2.1%, solid jobs creation, and a higher outright official interest rate versus other countries giving the Fed substantial room to move in easing monetary policy should it choose.
A good time to hold cash
Rob Holder, Crestone Wealth Management
In early August we witnessed a significant escalation in the US-China trade dispute, with new tariffs proposed by the US and subsequent retaliation by China in the form of currency devaluation and reduced purchases of US farm products. A situation which prompted a change to our tactical positioning with a shift to a more defensive stance, in particular, moderately underweight equities. These measures helped to protect portfolios as we saw equity markets move lower.
The further escalation in late August has led us to make a further adjustment, again reducing the exposure to emerging market equities and emphasising our preference for cash, fixed income and alternatives over equities.
Within fixed income we are marginally underweight high-grade bonds, although at a reduced magnitude compared to a month ago, owing to the heightened risk environment and the potential for sovereign yields to move lower as central banks ease policy further. Within credit we are neutral to international markets and have a modest overweight to domestic assets, where accommodative monetary policy and a solid economic backdrop should help suppress credit spreads.
Within equities we see escalating trade tensions as particularly negative for emerging markets and have moved progressively more underweight since early August. We are also underweight European equities, which are susceptible to both trade concerns and a weaker economic outlook, and UK equities, which are at the mercy of Brexit uncertainty.
We continue to believe that alternative assets offer attractive risk-adjusted returns, and this is currently our largest tactical overweight. In the current environment of heightened volatility, we are also recommending that our clients hold a tactical overweight to cash.
Wrapping it all up
While the details may differ slightly between respondents, the message is clear: stay invested, but hedge your risks. A high-quality hedge can serve the dual purposes of limiting the drawdown and providing liquidity to buy cheap assets when the timing is opportune. For example, Australian dollar gold appreciated by around 66% between November 2007 and March 2009, as the ASX 200 halved. Whether it’s gold, long-term bonds, alternatives, or good ol’ fashion cash, an appropriate allocation at the right time can make a huge impact on a portfolio’s returns.
Should you be ‘risk on’ or ‘risk off’?
This is today's critical question for investors and will be the topic of a lively debate at Livewire Live 2019 on the 10th of September. We’ve assembled two teams with over 150 years of combined investing experience to go head to head on this hotly contested topic.
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Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.
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