Interactive Investor

Shorting opportunities in Tactical Asset Allocator

14th May 2014 10:14

Ceri Jones from interactive investor

Valuations in developed world stockmarkets are sky high. UK forward earnings multiples and European price-to-book ratios have soared, while across the developed world a bull run in technology, social media and internet ventures has pushed multiples and new listings to almost-scary levels.

For example, Twitter trades at 333 times forward earnings and LinkedIn, which connects professionals with prospective employers, is trading at 84.6 times. Even the US consumer staples index trades at nearly 18 times next year's profits.

In Europe, Germany is continuing to power ahead, and after years of weak growth, austerity and economic reforms even the periphery countries are improving. Only France is a real concern, with a febrile labour market.

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Shorting opportunities

With dispersions in European equity valuations at their highest level in 30 years, bar the dotcom bubble of 2000, this is a perfect environment for long/short fund managers, such as the RWC European Absolute Alpha fund or Fidelity's FAST Europe fund.

The other big talking point is whether investors who in recent years have accessed emerging markets by buying companies whose customers are in emerging markets should start accessing these markets directly.

Since January 2011 most emerging world markets, with the exception of Indonesia and the Philippines, have underperformed the developed world by almost 45%. The culprits have included rising labour costs, excessive credit, deteriorating pricing power, opaque corporate governance and erratic dividend policies.

In practice what this means is that although emerging markets enjoy healthy rates of growth, there is surprisingly little by way of profits returned to the investor.

However, value opportunities are now appearing in the emerging world, and some company managements are beginning to appreciate the need for corporate governance and capital discipline.

The political backdrop is also changing. In India, Narendra Modi of the BJP is likely to win the imminent election and implement a reformist, business-friendly agenda.

China

In China, a radical overhaul of the financial system that should improve efficiency and the reform of state-owned enterprises should lift their efficiency, and eventually their dividends.

However, as reform proceeds, growth is likely to slow further from today's 7% to perhaps as little as 5%. This has raised the prospect of a second potential hard landing, and spooked the market, but it is worth remembering that the Chinese market has grown so remarkably in recent years that the predicted growth of 7% today is worth the same as 13% of the nation's activity seven years ago.

Fortunately, the government also has ample room for manoeuvre as public debt is under control, and recent fresh initiatives on infrastructure spending and bank bailouts suggest the leadership has no intention of succumbing to a major slowdown.

The case for an investment in frontier markets has also become more compelling in the light of multiple growth drivers that include favourable demographics, low labour costs, significant natural resource deposits, low debt levels, current account surpluses and large forex reserves.

These markets are less reliant on the developed world and in portfolio terms have less correlation with it. It should be possible to generate strong alpha in frontier markets because they are inefficient and typically under-researched.

That, however, also cries out for active management, so we are buying the Schroder Frontier Markets Equity fund, which has outperformed the MSCI Frontier Markets index since its launch in December 2010, returning 13.4% a year compared with the index's 7.3%. The fund is run by veteran Allan Conway, formerly head of global emerging markets at West LB AM.

It's been a dreadful month for the portfolio, with only two holdings - the iShares FTSE UK Dividend Plus and the iShares FTSE EPRA/NA Global Property fund - making any money. Selling at the bottom is no way to go, however, and there is reason to hope that its pronounced problems - the Russian-centred holdings and silver - will rectify over time.