Joy Bolli: Giles, before looking at next year, let?s have a look at 2010. What were the highlights and which investments made it big?
Giles Keating: It?s been a pretty up and down year for most investments, with events like the Greek crisis back in May. This means that some of the major asset classes, equity markets, the fixed income markets had some very good months, but also some very bad ones. Many are now finishing fairly close to where they began.One or two investments though do stand out as having done extremely well. One example is gold and some of the other precious metals. They?ve moved up very sharply. And the same applies to other commodities.
Your research teams have put together 10 top investment ideas spanning from fixed income to equities and currencies. Maybe you could start with the fixed income sector?.
You have to thread quite carefully in an environment where the trend in yields is likely to be in the wrong direction: that means upwards. So, you should take advantage: When the markets seem to become a bit too pessimistic about how rapidly rates are moving up is the point where you should be getting slightly more exposure to the length of time in your bond portfolio (idea 1). In the credit area, we think you should also still be looking at the more risky credit assets, some of the high-yield assets and carefully selected emerging market bonds (idea 2).
Especially emerging markets have been a top theme this year. Will they continue to be economic growth drivers?
The emerging markets will certainly continue to be drivers of growth. Growth and innovation is very much a theme, one of our main equity ideas for 2011. That includes some of the emerging stock markets where we think there is still scope, even after a good 2010 (idea 3).However, we would mention that some of the pessimism that has got in about the developed markets has gone a bit too far. We are particularly keen on companies in the developed markets that are continuing to innovate.
Can you give us a concrete example?
When America was under pressure from Japan back in the 1980s, we found that many American companies reinvented themselves. One example was IBM switching from hardware over to services and software. We think something similar can happen over the coming years. As the market picks up on that in 2011, some American companies could really do surprisingly well (idea 4).
We?ve begun to see an M&A wave picking up. Is that an investment idea?
We very much think so. This is our third equity idea. There is so much cash sitting on corporate balance sheets. In fact, it?s the highest level for over almost 50 years in America. We think companies are going to be spending it. Some of it will go to investment, but some of it will be in more mergers and acquisition activity. This is helpful to stock markets generally. But we also think it opens up opportunities for specialist investors (idea 5).
What can we expect with regard to the dollar and the euro?
Our feeling is that the movement between the dollar and the euro is not going to be the big story. Of course, there will be movements up and down, but we don?t see a big misalignment of those currencies. We instead see rather small movements between two currencies, where both regions have quite considerable problems. This can cause a lot of short-term trading action. But given that we?re not starting from a major misalignment, it?s difficult to see a major trend. Instead, we think the pound sterling has got the opportunity to move up somewhat. It tends to do that during the economic upswing. Also some of the emerging market currencies still have upside potential. Right now, the Mexican peso could be an example (idea 6).
What about commodity strategies?
Commodities had a very good year in 2010. In 2011, we think the trend is still upwards, but not as strong and not in the same style. So, for 2011 our preferred idea is to look for where upward momentum is developing in a block of commodities. Take advantage of that, but be ready for that running out of momentum and for the need to switch to another block of commodities toward which the momentum is shifting to.This is a strategy that?s a bit different from 2010 where more or less any commodities did well. In 2011, you really got to keep choosing which area and perhaps switch between them (idea 7).
What about hedge funds?
We do think hedge funds should play a role in portfolios. We have a hedge fund barometer where we look at factors such as liquidity conditions or whether hedge funds are herding into one area of the market and other important factors. Our barometer at the moment is signaling a fairly healthy environment for hedge funds. So, it?s a good moment to have hedge funds as part of ones portfolio and some of the macro funds, we think, can do quite well (idea 8).
Rising real estate prices in Asia have made headlines this year, how will this area develop?
If we look around the world, we have a wide diversity from the ongoing slump of residential prices in America on the one hand, through to the boom of residential and commercial prices that are developing in Hong Kong and parts of China. Our approach is to look rather carefully at the yields that are on offer, particularly at the commercial real estate area. Some of the yields still look very attractive, for example some of the US West Coast?s commercial real estate yields, and to a lesser extent the East Coast. The yields that you get on good quality commercial real estates are standing well above the government bond yield, which is a favorable indicator.The same applies to some of the European commercial markets. When we look to Asia, we find that this gap has disappeared. In other words, commercial real estate is yielding the same as the relevant government bond yield, perhaps even a little bit less. And that begins to become a warning signal. It says that over the next couple of years it really doesn?t offer value in the way that the other markets mentioned do (idea 9).
It sounds like 2011 will be a good year. But what if things go badly wrong?
That?s a very important question. We?ve prepared a number of ideas to try to balance those more optimistic views. One obvious area people are looking at is gold. As said, gold was a very good investment in 2010, but that means that the starting level as we go into 2011 does look reasonably high. So, if you want to use gold as a kind of counterbalance to some of the good news investment plays, then you could consider well out-of-the money call options on gold. They are certainly not looking cheap, but they do provide a form of balance.We also look at other ideas in the same area. For example options on the Swiss franc against the euro, because the Swiss franc will probably do very well if the rest of the financial system were doing very badly. One can look to options on the VIX, which is the indicator of volatility in the stock market, and that tends to go up, if the stock market tends to go down (idea 10).
But the big message here is that there is no easy way to protect against these kinds of problems. The first line of defense should always be a well diversified portfolio in line with an investor?s preferences. And I hope that some of our ideas help to provide the building blocks to such a portfolio.
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