Asset allocation: What it is going to look like in the near term

A year ago, as equity markets collapsed and real estate prices headed towards a precipitous decline amid the global recession, investors fled to safety.

Globally, stock markets witnessed a selling spree and funds faced massive redemption as investors opted for cash and government bonds until almost the end of the first quarter of 2009.

Equities picked up by the middle of the year, though marked by severe volatility, and gathered considerable momentum in the months ahead. Investors split their allocation between equities and bonds, but there were those who held on to some cash too.

As the year comes to an end and 2010 dawns upon us, there is an air of caution. Having had a roller coaster ride in 2009, the global capital market, Jeff Singer says, is going to have a "bumpy journey" ahead this year (see his column on page 32). The rally in the global stock markets has slowed down and they are more sideways these days. But year to date, the S&P500 is up 24 per cent, the UK's FTSE100 22 per cent, Japan's Nikkei almost 19 per cent, Shanghai Composite Index 70 per cent and India's Sensex, an equally spectacular 79 per cent.

Asset managers and financial advisors still favour equities—in fact, most being equal or overweight on this risky asset, though as some believe, this strategy is likely to change in the second quarter and thereafter. Optimism in emerging markets, particularly those in Asia, reigns, though the risks of high inflation and asset bubbles are cited in order not to get too carried away.

With yields having thinned, bonds have fallen out of favour, though as some managers feel there are still some returns to be had in some of the riskier grades. So, what is the asset allocation going to look like in 2010?

Equities still hold sway, with views varying on other assets such as bonds, real estate and gold. "I would carefully equal weight equities," said Sami Benghezal, assistant vice president, asset management, Abu Dhabi Commercial Bank.

"I would only invest in countries that are not over reliant on exports of manufactured goods and with a healthy banking system where credit grows at a reasonable rate and a strong domestic demand. India would fit the definition. I would also invest in commodity exporting countries, mainly because we're still in the early phase of a secular trend of growing demand for commodities."

Note of caution

But he adds a note of caution. "Global markets returns in 2010 will probably not mirror those of 2009," Benghezal said. "I think that current level of equity indices is fairly high, and unless further data validates the good state of the economy, stock markets will be range bound."

The private investment bank Sarasin-Alpen are still overweight equities, but are looking to start selling into a strong market in the first quarter of 2010, according to executive vice chairman and CEO Rohit Walia. His strategy would be to rotate into defensive sectors such as telecoms and consumer staples and underweight consumer cyclicals and financials.

Tudor Allin-Khan, chief economist of Al Futtaim HC Securities, favours equity over sovereign bonds and other defensive assets such as gold.

Globally, Walia expects a strong start into the year with upside potential of about 10 per cent. Dubai stocks may recover a little more as the recent Dubai World concerns are being addressed, he said.

All agree that the sentiment on Dubai and the UAE markets depends largely on clearing the uncertainty surrounding Dubai World's debt restructuring plans and its ability to repay its creditors.

"If the [Dubai World] issue is settled in a way that is viewed as satisfactory, foreign funds will flow again and local markets will play a vigorous catch up game with other emerging/frontier markets, if not, we're likely to experience further volatility, which is more suitable for traders than long term investors," Benghezal said.

Matthew Wakeman, managing director, cash and equity-linked trading at EFG-Hermes, is much more hopeful, though he also echoes the same view, saying the debt restructuring issue will remain a key news flow event until we hear that an orderly agreement has been reached with debt holders.

"The UAE growth story is still very much intact with non-oil GDP continuing to increase coupled with domestic companies diversifying and expanding outside of the country.

"The global position and dynamic environment of the UAE means that as a trading hub between the east and the west, it's hard to beat" he said.

He picks Emaar Properties and Arabtec as the best buys in Dubai, given that both companies are increasingly well diversified and offer good potential. And with ongoing infrastructure spending in Abu Dhabi, he favours Aldar. He also thinks First Gulf Bank will perform well in the banking sector.

The reversal of the US dollar carry may add pressure to a number of non-dollar denominated equity markets, namely BRIC, whilst GCC markets outperform, Allin-Khan said. "An increase in risk appetite in 2010 will see emerging markets outperform developed markets with Dubai likely to present a big buying opportunity to investors."

Concern

But concerns that global growth may be slowing with recession fears possibly rekindling makes Walia cautious for the second quarter.

"As of quarter two of 2010 we should be underweight stocks and overweight government bonds," Walia said.

To shield oneself from the effect of inflation on fixed income securities, Benghezal points out the importance of selecting only real return bonds and Tips (treasury inflation protected securities).

As for investing in gold, none of the managers and analysts seems to favour it, though they have their nuanced differences in how the precious metal might fare going forward in 2010. In the past few weeks, gold has hit a bump as the dollar showed signs of some stability. Gold was down to about $1105 an ounce yesterday from the record highs of $1227.

"The bullish run in gold was due to its attribute as a store for value and growing uncertainty," Benghezal said.

"I personally would favour investing in a basket of real commodities instead of investing solely in gold.

"At least for most of the other commodities real demand has a real effect on prices unlike gold, which at the moment looks more prone to speculative forces more than anything else."

Though he is no great fan of gold, Walia's view is different. "It should perform better than commodities and real estate, which will suffer if the cycle goes into reverse," he said.

What about real estate with news about house sales slowly picking up, though prices still remain beaten down? Opinions differ, depending on the market.

"Despite its attractiveness, [because of] depressed prices and hedge against inflation, real estate is not on top of my list," Benghezal said.

"My main concern being the draught of the securitisation market which fuelled the real estate bubble and caused the credit crisis. Therefore, one needs to be cautious before investing in real estate; countries with substantial demographic growth and tangible housing shortage are a better option than real estate in the developed world."

Without being specific about markets, Allin-Khan looks at this asset as an attractive opportunity to long-term investors as global economy recovers and willingness of banks to lend recovers.

"It will also provide protection to investors from inflation shocks that are expected in 2010," Khan said.

As for other alternative asset classes, hedge funds are preferred. The "main reason [in favour of such funds] is they can generate returns in every scenario, and a small allocation can do marvels diversification wise," Benghezal said.