Where to find value in this new reality

Exposure to defence stocks, cybersecurity, and aerospace sectors will undoubtedly create value for the overall portfolio in the new reality.

The new order of the moment characterised by high inflation rates, uncertain geopolitical risks, interest rate hikes, a surge in commodities prices among other painstaking macros, pose serious threats to a portfolio manager’s directional views thus dampening risk-adjusted returns. Be that as it may, it’s not all doom and gloom, just like a seesaw, when one asset class or sector goes down another goes up. So how do you position your portfolio without absorbing sizeable risks and costs based on the new reality?

A manager is rewarded based on skill and noise, the latter being fundamentally anchored on luck, which is not sustainable. Every manager seeks to preserve and grow capital despite a given economic cycle, this is enhanced by either following the trend or having contrarian views. If the views are correct, the ability to outperform the benchmark is laudable given the surrounding current near-term market volatilities.

For example, in a rising interest rate environment, to tame mounting and persistent inflationary pressures, tech stocks are heavily affected thus weakening overall performance if allocation to tech stocks is a significant part of the asset allocation. Notwithstanding that, short-dated instruments, and financials, tend to enjoy such a macro-economic move thus creating a seesaw type of movement. This foregoing example depicts how portfolio positioning and timing is necessary to curtail both systematic and idiosyncratic risks.

Furthermore, the current macro-economic reality creates a myriad of unique challenges to many portfolio managers in terms of tactical asset allocation, strategic asset allocations or hedging strategies etc. This unsurprisingly calls for a well-oiled approach to steer away from return reduction risks. Gold, a store of value and a safe haven, which saw unprecedented highs, touching US$2 020.00 per ounce in recent days, following heightened geopolitical risks, could materially be a diversifier sweetener as a result of its uncorrelated effects to other asset classes. In that vein, having exposure to basic materials could potentially smooth returns for a portfolio.

In the past few days, the US Senate passed a profound $1.5 trillion spending bill, with 52% of this expenditure channelled towards defence, up 5.6% from present levels. Following Russia’s invasion of Ukraine in late February 2022, cyber-attacks from Russia against the US and Europe have soared phenomenally presenting serious operational risks for government and corporates. This spending bill consequently creates opportunities in defence stocks, cybersecurity, and aerospace sectors. Therefore, exposure in such sectors will undoubtedly create value for the overall portfolio in the new reality.

Inflation which has skyrocketed to decades highs in the US and elsewhere has ushered in a wave of interest rate hikes by many central banks, thereby affecting stocks markets, particularly technology stocks. The ripple effect of this is that stocks with a weaker pricing bargaining power will experience reduced margins or might be forced to extensively restructure. On the contrary, stocks with excellent pass-on-costs tend to benefit from rising inflation. Depending on the dynamics of the portfolio, exposure to stocks that enjoys economies of scale as well as commanding a strong price bargaining power would add value resulting in amplified returns.

These directional views are largely based on being a first mover and also importantly, on how fast other market participants process information in fragmented markets. Market sentiments, a behavioural finance bias, plays a pivotal role in value addition and value reduction thus must be accounted for when implementing directional views.

In all this, consistency to a well spelt out investment strategy is of sheer importance in driving and enhancing returns regardless of the macro-economic dynamics. Separating skill from noise through avoiding inherent human behavioural bias be it cognitive or emotional biases is crucial in achieving stated portfolio goals, no matter the changing times.

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Mauro Forlin

Global & Local Asset Management


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