• Written by 
  • 14/12/2016

Sometimes less is more. In a world of rapidly expanding information overload, the ability to filter out what really matters has become a key competitive advantage.

Bark versus bite: our key investment themes for 20 ...2 of 10 Compass Q1 2017

Residents of the United States, please read this important information before proceeding

Please read this important information before proceeding.

During the past year the political risk that dominated the information flow and narrative turned out to have very limited impact on economies and capital markets, which continued to take their lead from improving fundamentals. Looking into 2017, we continue to rely more on our key fundamental indicators and tune out much of the political concerns. With this approach, we don’t see an imminent end to this market cycle and therefore continue to be overweight risk assets.

Any outlook for the new year is supposed to have a list of themes. And we don’t want to disappoint you. But, given that we believe that the real value is not in long lists, but in the filtering of this information, this edition of Compass has a shorter and hopefully more focused list.

The first theme is that that we currently don’t see an end to this economic and market cycle. This view is formed by the signals from the five key filters or indicators we use to monitor the probability of the end of the cycle being around the corner. These indicators are based on theory and have statistical support. But we still overlay them with experienced judgement, especially during unusual price episodes, be it oil or interest rates. You can find more details about our indicators in the Investment Strategy section.

The second theme is political risk, with a focus on Europe. After the Italian ‘No’ vote to constitutional reform, the focus has been shifting to the Netherlands, France and Germany. Our view is that these political events will have a very limited impact on economies and markets. Only a Marine Le Pen victory in France would seriously rock the boat and we put a low probability on that outcome.

The third theme is emerging market assets which we think will recover on the back of healthier growth and protectionist fears receding, as the Trump administration tones down campaign trail rhetoric. Our fourth theme is equity sector reflation trades, focusing on the importance of the yield curve for banks. And our fifth and final theme is about the safe haven investments, in case we are wrong or the world changes.

Next, we cover impact investing, an area where we see considerable interest and where we think you can combine having a positive impact on society with attractive financial returns. Companies with high ESG standards (environmental, social and governance) are usually well-run with less headline risk and higher-quality return streams. Following this section, we focus on the behavioural aspects of assessing your investment results at year-end and longer time periods, and provide an update on our tactical positioning.

Finally, some thoughts on the negative bias we have seen for some time in markets, where many investors have been overly concerned and sometimes acted unnecessarily on perceived risks. Being sceptical and focusing on what can go wrong is often viewed as being analytical and well-informed. This bias became more accentuated after the Global Financial Crisis in 2008-09, when shell-shocked investors found themselves in the uncomfortable position of having to stretch for yield and risk in a low-return environment. This increased the demand for downside protection, ideally without having to give up much return. However, many of these ‘hedges’ or insurance solutions turned out to be costly and less affordable when returns were lower.

The best way to approach this challenge is to try to be symmetrical, to be equally sceptical against both bullish and bearish ideas. We also have to try to avoid being embarrassed when we change our minds, as long as it is based on unbiased analysis. Another important point is to create the room to act ‘counter-cyclically’ – to buy low during crises and sell high during good times – thereby improving the scope to add value over time. To be able to do this, we have to make sure clients clearly understand, and are comfortable with, the risk levels we are targeting. Finally, don’t forget that the most cost-efficient defence against bad outcomes is diversification.