Alternative Assets Offer Investment Income

In an investment world where both equities and bonds look expensive, Morningstar Investment Management's Dan Kemp considers alternatives

Dan Kemp 5 January, 2018 | 7:56AM

Morningstar Investment Management has high conviction in sterling

Valuations and risk change over time in investing; bubbles and busts exist. The key is to maintain a robust and repeatable framework that puts investors’ interests first and sets the probabilities of success in your favour.

Among stock markets, we have the greatest conviction in UK and Japanese equities. Among bonds, emerging markets fixed income offers opportunities. But investors should not forget alternative assets for a balanced portfolio.

Global Real Estate: Low Conviction

We maintain a low conviction view on global REITs, with valuation-implied returns insufficient to justify the risk of the permanent loss of capital from these levels. Indeed, the asset class remains vulnerable to rising U.S. interest rates, which we expect would have significant long-term implications for asset valuations and debt-funding costs.

Global Infrastructure: Low Conviction

While changes in interest rate and inflation expectations have impacted other interest rate sensitive asset classes – such as listed property – global infrastructure has been relatively immune, with the asset class performing strongly across 2017.

This has exacerbated our already cautious view. Indeed, we are becoming increasingly concerned that valuations in the sector are unsustainable, believing there to be the risk of material capital losses from these levels, particularly as we appear to be entering into a rising interest rate environment. 

That said, expectations of increasing infrastructure spend as Central Banks look to hand over the stimulus baton to governments to enact fiscal policy, not to mention the potential infrastructure bonanza under Donald Trump which has underpinned much of the gains of late, may see certain sectors of the global asset class, especially those assets more leveraged to the economic cycle, supported in the short to medium term.

Pound Sterling: Medium to High Conviction

Recent strength in the British pound, which previously bore the brunt of Brexit uncertainty, opened up a valuation opportunity. While our conviction has tempered somewhat following recent strength, we see merit in maintaining a strong home bias.

In aggregate, this means we favour being predominantly hedged, subject to individual portfolio investment objectives and risk profiles, with exposure to foreign currencies also expected to provide diversification qualities and help preserve capital in times of market stress.

Alternative Assets: Medium to High Conviction

In a world of low bond yields and overvalued stocks, alternative assets increasingly appeal given that returns from this asset class have a lower direct relationship with the performance of traditional asset classes like equities and bonds. Investment selection remains critical, however, with our preference for genuinely diversifying assets with a focus on reasonable cost and liquidity.

Cash: Medium to High Conviction

In an environment characterised by expensive global equity and fixed interest valuations, cash increasingly appeals as an asset class that can protect capital and act as ammunition against a market setback. Put simply, we are not getting sufficient reward for the risk of being more fully invested at this time. If key asset prices move closer to their fair value, or what we think they are really worth, then our cash reserves will serve two purposes.

First, cash should help buffer the portfolio from any future volatility resulting from a fall in equity markets. Second, cash provides us with ample liquidity to take advantage of investment opportunities as they arise. This means we will avoid having to sell down existing investments to fund purchases, at what may otherwise be an inopportune time to sell, with price weakness often induced by investor fear and panic.

 

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA