Economic uncertainties raise concerns for equity exposure
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September 16, 2019 12:00 AM

Economic uncertainties raise concerns for equity exposure

Sophie Baker
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    Johanna Kyrklund
    Johanna Kyrklund sees the potential for anemic growth to lead to outright recession.

    Continuing economic and policy uncertainties have institutional investors and money managers split on their approach to equity exposure.

    Despite volatility, markets are rallying overall — but some investors are still exercising patience while others are taking a risk-off approach.

    A white paper published by investment consultant bfinance last month, titled "Five Levers for Reducing Equity Risk," concluded that the assessment and control of equity risk exposure is an increasingly important priority for asset owners this year. The paper cites an investment portfolio made up of 55% equities, 31% bonds and 14% alternatives, and shows risk contributions to that portfolio to be 91% equity, 7% bonds and 2% alternatives.

    Also published last month, capital markets firm Preqin's "Investor Update: Alternative Assets H2 2019" found that 74% of investors believe equity markets are at a peak. That compared with 61% of respondents to the same question at the end of 2018. The findings came from a July survey of 177 institutional investors.

    Institutional investors have been altering their equities allocations over recent months. Pensions & Investments' analysis of Investment Company Institute data showed equity mutual fund outflows of $43.7 billion in August, marking the sixth consecutive month of outflows.

    Among investors:


    • In August, the $13.3 billion New Mexico Educational Retirement Board, Santa Fe, chose a new asset allocation, which saw exposure to private equity and other asset classes increased at the expense of domestic equities — down 2 percentage points to 14% — and other investments.
    • In June, the $25.8 billion New Mexico State Investment Council, Santa Fe, selected new target allocations for two of its endowment funds. Broad U.S. equity exposure and broad international equity allocation were reduced to 10% from 33% each for the Tobacco Settlement Permanent Fund. The Water Trust Fund saw its broad U.S. equity target allocation and its broad international equity target exposure fall to 10% from 15% each.
    • Singapore's more than $100 billion sovereign wealth fund GIC Private Ltd.'s July annual report for the year through March 2019 showed the fund's developed market equities allocation fell to 19% from 23% a year earlier.

    Uncertainty grows

    Money managers have also shown uncertainty over equities. The August edition of Bank of America Merrill Lynch's monthly fund manager survey showed the allocation to global equities fell 22 percentage points to a net 12% underweight. BofA surveyed 224 money managers representing $553 billion in assets under management.

    The topic has been exacerbated by rising equity markets so far this year: the MSCI All-Country World index returned 15.55% year-to-date through Sept. 12, compared with a -11.18% return for 2018. The S&P 500 index has gained 20.1% so far this year vs. a 6.24% loss in 2018; and the MSCI Europe index has returned 15.3% so far in 2019, compared with a 13.1% loss in 2018. Performance figures are in price-return terms.

    Two "interlinked and somewhat offsetting trends" of ample central bank liquidity and a weakening economic cycle "continue to intensify with more central banks joining the 'cutting club' and the risk that political events (such as trade tensions and Brexit) might push an anemic growth environment into outright recession," said Johanna Kyrklund, global head of multiasset investments at Schroders PLC in London.

    Schroders' multiasset team has chosen to stick with its expensive positions for now, including defensive and growth equities, gold and high-yield debt, "given the absence of positive cyclical catalysts." She said an improvement in the trade war rhetoric between the U.S. and China would prompt a relief rally — although it is "difficult to predict tweets and there is evidence that the underlying tone of global trade is weak irrespective of the political environment."

    Ann-Katrin Petersen, Frankfurt-based vice president and investment strategist at Allianz Global Investors, said investors have abandoned their expectations of rising global policy rates and now anticipate more rate cuts this year.

    And Ms. Petersen noted that geopolitical risks and late-cycle headwinds haven't disappeared. "In other words, the performance of risky assets year-to-date has not been confirmed by cyclical macro data. Meanwhile, the risks of an ongoing escalation of the U.S.-Sino trade war and potential currency war have increased," she said, noting that the "worrying longer-term trend of using protectionism as a general geopolitical weapon was also highlighted by the latest heating up of the (trade) conflict between Japan and South Korea."

    For AllianzGI, medium-term risks of a more significant global downturn have continued to rise. "Even the so-far resilient world's largest economy, the U.S., has entered a late-cycle limbo in which it faces an increasing medium-term fragility, albeit so far without exhibiting the usual end-of-cycle dynamics that precede the immediate outbreak of a recession," she said.

    The Federal Reserve cut rates in July for the first time since December 2008, and could do so again at its meeting later this month.

    "Global growth is decelerating, business confidence is waning, there's greater corporate caution and risks to company earnings have increased," said Katy Thorneycroft, managing director in J.P. Morgan Asset Management's multiasset solutions team in London. "From our perspective, we would need to see much stronger earnings growth to increase equity exposure."

    Ms. Thorneycroft said the favored equity market remains the U.S., in "spite of our reduced overall weighting to equities." She said the risk of a recession in the U.S. over the next 12 months "is slightly elevated but our base case is that the U.S. isn't in recession territory just yet."

    U.K. equities also look attractive thanks to dividend yields, although allocations may change come October and the U.K.'s planned exit from the European Union, she added.

    Weighting equities

    Among money management executives, trade wars were cited as having a huge effect on equity markets and sentiment.

    AXA Investment Managers is underweight equities due to the trade war and too-high expectations on the U.S. Federal Reserve, said Serge Pizem, global head of multiasset investments in Paris.

    Money management firm Fidelity International has moved increasingly to a defensive positioning, said lead cross-asset strategist Wen-Wen Lindroth, based in London. "Market conditions are an increasingly combustible mix. Despite bullish signals from our proprietary indicators and a fairly rosy corporate earnings outlook from our analysts, we are heeding numerous warning signs," including late-cycle dynamics, nervous bond markets, rich valuations and complacency in some parts of the markets.

    The firm adjusted its house view on equities in July, with a near-term downgrade to moderate underweight "reflecting the increasing risk-off sentiment among our portfolio managers."

    And it's not just money managers looking to downplay equity risk in their portfolios. Michael Buchenholz, head of U.S. pension strategy with J.P. Morgan Asset Management's pensions solutions and advisory team in New York, said he's seen pension funds structurally taking down public equity risk. Clients are also tactically reducing equity and/or looking for shorter-term hedges by using options.

    And despite bfinance's findings that reducing equity risk is a top priority for asset owners this year, these investors still have to strike a balance.

    "Yes, there are these concerns around where we are in the cycle — in the latter stage — and what that means for equity portfolios," said Justin Preston, senior director, head of equity, public markets research at bfinance in London. However, "a lot of clients still need to retain a certain level of equity exposure."

    "There's an element of caution — there is so much headline risk out there," from President Donald Trump's tweets, to developments in and related to China, and the fact that the bull market has lasted 10 years, Mr. Preston said. "People are cautious for the right reasons. But it is difficult to know where the end point is."

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