Strategy Update
Genevieve Signoret
In this blog entry, I update you on our current (liquid) portfolio strategies.
Our rosy outlook has lost some shine
Last Wednesday 27 March, on our sister blog, Timón Económico we shared updated scenarios for the world economy and global markets in 2018–19. While our outlook is still rosy, compared with a few months back, it has lost some of its shine: we have lowered the (subjective) odds we assign to our benign central scenario from 80% to 75% and raised those of our pessimistic risk scenario to 15% from 10%. Also, because of Nafta uncertainty and the strong chance that Andrés Manuel López Obrador will become president, we have revised sharply down our central scenario growth and exchange rate projections for Mexico. This singling out of Mexico for pessimism explains why we included the word External in the name we gave our central scenario—External Calm.
But we’re not shifting out of risk assets
While less lustrous and certain than before, our central scenario remains benign and high-probability. Thus, we are not lowering allocations in client portfolios to risk assets[1] relative to safe-haven (quality)[2] assets. For clients whose investment horizons exceed 10 years, we continue to invest in risk assets alone.[3] For 5–10 years out, our risk-quality split remains 80%-20%. For the next 2–5 years, it’s 60%-40%.
Shunning the peso, adding some gold
That our central scenario has lost shine, especially for Mexico and the peso, means that we are now almost completely avoiding the Mexico peso[4]. Because many of the risks to our central scenario are geopolitical, and because under central scenario assumptions we see the European Central Bank (ECB) and Federal Reserve (Fed) tightening their stances, we are again categorizing gold as a safe haven and opening small positions in it.
No more than half our bonds in U.S. Treasuries
We remain bearish on the U.S. dollar relative to the euro and yen loath to over-expose clients to Treasuries with the Fed so hawkish and so prone, in our view, to make a mistake (tighten too fast). So we continue to caps bond allocations to U.S. Treasuries of 50% and target an average duration for U.S. Treasuries to 6-10 years; we’re putting the rest into mostly non-U.S. developed economy sovereign and high-quality corporate bonds of long duration.
A similar rule applies to real estate
Half our real-estate–linked assets, while still developed-market, are now non-U.S.
In equity, we’re overweight EM
To allocate equity internationally and across market caps and sectors, we assign a good chunk of each equity portion of client portfolios to a core position in a market-weighted all-country stock index fund and the rest to “overweights” in accordance with “calls” (signals to Buy, Sell, or Hold) we “hear” from a proprietary quantitative model that analyzes market indices we can invest in through ETFs that meet our strict criteria as to cost and liquidity.
Today, we’re underweight the expensive U.S. stock market and developed markets generally and overweight emerging markets. Within emerging markets, we’re overweight Russia, Brazil, and South Korea; within developed markets, the UK.[5]
The bottom line
In summary, we remain heavily overweight emerging markets while shunning Mexico, and continue to cap at 50% U.S. bond and real estate holdings. Also, because of projected monetary tightening and heightened geopolitical risks, we’re now categorizing gold as a safe haven and opening small positions in it.
Appendix
Note on subjective probabilities
Our model portfolios and their benchmarks
[1] All positions are long. We define a risk asset as any that is not a safe-haven asset. Examples include stocks, real estate-linked assets such as REITS, alternative assets such as commodity futures, emerging market bonds (even if sovereign), and corporate bonds not A-rated even if issued in a safe-haven country and currency.
[2] We define a safe-haven (or “quality”) asset as a bond issued in a safe-haven currency with a global credit rating of A or above. We identify as safe-haven currencies are the Japanese yen, Swiss franc, U.S. dollar, euro (the least reliable in this list), and a few Scandinavian currencies. Notice that none in this list exhibits a strong positive correlation to commodity prices, which it why the list omits the Australian and Canadian dollars. We are exploring the possibility of adding the Great Britain pound back into this mix soon after having removed it around the date of the Brexit referendum. We view gold as reliable safe haven only for extreme events.
[3] For clients we perceive to be risk intolerant relative to their investment horizons, we adopt much lower exposures to risk assets than those stated in this paragraph.
[4] Unless of course our mandate is to produce peso cashflow for the client over the next two years. Near-term peso requirements are laddered in Cetes.
[5] Not all client portfolios have these precise overweight positions. We let overweight positions mature (we await Sell calls from our model) before closing them out and entering new ones.