Why strategic tilts are key to outperforming priced-in market

Global chief strategist on asset classes macro investors should look at in low-return environment

Why strategic tilts are key to outperforming priced-in market

As the economic system heals and global growth recovers, investor confidence has risen. However, a dose of realism is required, according to HSBC AM’s global chief strategist.

Not only has much of this optimism been priced into markets but expected returns have fallen over the past year. Joseph Little, therefore, has urged investors to pay close attention to their asset allocation. While he cautioned against positioning too far from your benchmark allocation of your “home portfolio”, to outperform in this low-return world, HSBC supports strategic tilting to parts of the market which are mispriced for the medium term.

These are few and far between, however. But among the 300 asset classes the bank tracks each month, it sees the clearest valuation anomaly in Asian fixed income. It also sees a strategic opportunity to increase illiquid holdings to boost returns via alternative asset classes like infrastructure.

Little said: “The restoration economy consolidated in Q1 2021, as the economy entered healing mode and global growth began to recover. We think this will continue into Q2 as economic re-opening, pent-up demand and fiscal stimulus combine to bolster an already strong outlook for corporate profits.

“However, as economic optimism is already factored into market prices, favouring cyclical asset classes is not as easy as it looks on paper. But based on our analysis, we think a structural tilt to emerging markets and alternatives, and a cyclical tilt to value equities could help macro investors outperform in this low-return environment, as low-for-longer central bank policy and limited long-term inflation prospects keep bond yields in check.”

He added that President Joe Biden’s stimulus package could deliver upsides to consumer spending, bringing U.S. GDP in line with, or marginally above, the pre-COVID trend by mid-2022. However, Little believes the outlook for Europe looks overly pessimistic over the next 12-18 months.

HSBC’s stance is that there is a skew in the future return profile for value and cyclical equities.

“European and ASEAN markets have lagged over the past 12 months, given their bias to these areas of the market and relative underweights in technology and quality,” Little explained. “HSBC AM suggests there is scope for investors to be surprised by the delivery of the recovery through the rest of the year, and as such there is a possibility of an asset price overshoot. It therefore concludes that a cyclical tilt to benefit from a continued revival in value still makes sense.”

On the fixed-income side, there are concerns that higher bond yields may curtail the recovery but there are several constraints. Firstly, the inflation scenario looks relatively benign over the long term and, secondly, central bankers remain sanguine about the inflation outlook with policy commitments to asset purchases, lower for even longer rates, and further policy innovation remaining in place.

Little added: “Investment markets are approaching key levels for US treasuries; a 2% yield on 10-year Treasuries implies a bond premium of 1%. HSBC AM concludes the market will consider this enough compensation for current inflation risks. 

“Additionally, as an easy Fed and the global macro-recovery cause mild downward pressure on the dollar, the second key risk – that the dollar short squeeze becomes a trend - will be kept at bay. HSBC AM therefore remains confident the restoration economy will continue to show momentum, although at a critical time for the recovery, it will continue to monitor macro, policy and virus trends closely.”