Too risky to short the recovery, investors warned

Global strategist says regional equity allocation will be important and the case for private debt is strong

Too risky to short the recovery, investors warned

The intensified regime of lower-for-longer interest rates requires careful navigation but investors should not short the economic recovery.

That’s the view of Joseph Little, Global Chief Strategist at HSBC Global Asset Management, who believes that, in terms of portfolio positioning, it’s too risky to be selling or be underweight the restoration economy.

The speed with which this happened in Q3 was surprising, he said, although the recvoery is now flattening. He told WP: “We are in the restoration economy phase. The precise cadence of recovery – and even if we can expect a faster reflation in 2021 – depends on where we are in the world, the vaccine and policy support.”

In the U.S., more economic momentum, greater policy activism, a willingness to live with the virus and being first in line for the vaccine should help sustain a relative growth advantage. Europe, however, faces some significant near-term challenges, including a second wave of the virus and economic contraction in the fourth quarter. Little said: "After that, we anticipate a strong first half recovery next year, but the latest setback increases the risk of economic scarring from the crisis.”

Regardless of aftereffects, he maintains that economic restoration is more realistic than a rapid reflation scenario, and that the premature withdrawal of policy support remains the principal downside risk to the cycle

For investors, he said that an overweight position in equities still makes sense, but that regional allocation will need to adapt through the year to reflect new developments and evolving macro trends. Private equity will become an increasingly attractive option.

He explained: “The case for substituting some listed equity for a private equity allocation is strong. Not only do overall listed equity expected returns look low relative to most investors’ needs, but the set-up for private equity is also supportive. That is because returns are tilted to high-beta, small-cap and value factors, which should do well as recovery progresses.

“Further down the risk spectrum, we think there are some good outright valuation opportunities in Asian and emerging market credits, which will help balance investors’ portfolios from being too pro-risk.”

Global government bonds, however, are likely to disappoint investors on returns and as hedges. Little prefers U.S. treasuries and index-linked bonds, but said investors need to look elsewhere for diversification.

“These can be found in liquid alternatives such as commodities or systematic trend-following strategies,” he said. “Within illiquid alternatives, new diversifiers include securitised and private debt or multi-strategy hedge funds. In the world of lower-for-longer expected returns, embedding alternative allocations into our portfolios needs to become mainstream.”