Cautiously optimistic
O’Halloran doesn’t like cash but is rotating into alternative areas, hedge fund of funds and some thematic equities, such as renewable energy and water, which offer “multi-decade sources of alpha”. They are structurally growing and not caught up in global macro debate.
The group is a fundamental investor with a 12 to 18-month asset allocation time horizon. This comes from a structured process within a detailed macroeconomic framework. It also values markets region by region, theme by theme.
O’Halloran says: “We have specific benchmarks we allocate around. We take positions on those benchmarks depending on our conviction. We would tend to come up with risk/reward expectations on a rolling basis.
“For each asset class, we have a central scenario, a best-case and a worse-case scenario. We model expected returns in each of those. For global equities, a ‘muddle-through’ scenario would be a return of mid to high single digits, our best case would be a mid-teens return, while a worst case would be down 20%. That would be typical.”
An open-architecture, best-in-class approach is employed for fund and security selection, looking for the best funds or instrument to implement an idea. For commodities it is typically ETFs, while for global equities or water equities, there is more emphasis on the bottom-up, stockpicking component.
Where appropriate, O’Halloran makes use of passives but he says that now is not the time. “There has been a lot of hysteria on active versus passive and it is reaching a crescendo. There is so much written on it. When you get this kind of hysteria, it’s usually the time to go the other way.
“With dispersion in markets getting bigger, good active managers should have a better time ahead. We need to capture additional alpha for a total return perspective.”
After the recent market setbacks, opportunities are starting to re-emerge. Nevertheless, according to O’Halloran, some risks remain. This argues for an optimistic but cautious approach. LW
Five key themes
Brexit Britain
The UK is in suspended animation. At some point, it will be vulnerable to a shock. We remain cautious as there is a lot of uncertainty. Reflation and a drop in business investment are the big unknowns for the UK in 2017. It could come unstuck but doesn’t look good on a risk/reward basis at the moment.
Volatile year
The catalysts for volatility this year are: president Trump’s early policy where headline risks abound, particularly on foreign policy; Brexit uncertainty; national elections in France during the first half of the year and Germany in the second could create problems; and there could be issues following further rate rises by the Fed.
Thirst quenching
We like areas that have a structural growth story. Spending on US water infrastructure has been too low for too long and needs to increase substantially. Our water investments are based around infrastructure stocks, companies that are building or providing equipment and services for that infrastructure.
Earnings up
The earnings outlook is likely to be important for markets in 2017. Companies have started to deliver stronger earnings after a ‘lost year’ in 2016. US corporates may hit 6-7% growth this year, while Europe and emerging markets are likely to see double-digit rises. Earnings growth is particularly strong in a number of key sectors: financials, energy, material and industrials. This is being driven by better economic growth.
Shopping around
Active versus passive is reaching a peak. As contrarian investors, when there is this kind of hysteria, it is usually time to look elsewhere. Dispersion is getting bigger. Good active managers should, therefore, have a better time in store.
