As uncertain economic conditions continue to impact investments, financial advisors should help clients protect their portfolios through the use of tactical asset allocation, according to investment strategists at BMO Global Asset Management.
Speaking at conference on exchange traded funds in Toronto on Thursday, Alfred Lee, vice president and investment strategist at BMO Global Asset Management, noted that even though market volatility eased over the first quarter of 2012, advisors should brace clients for the possibility that high levels of market turbulence could return.
He pointed out that in the past week, markets have declined in reaction to the resurgence of European debt crisis concerns and uncertainty around the recovery of the U.S. economy. As a result, the Chicago Board Options Exchange Market Volatility Index – a popular measure of market volatility – has recently risen to levels above its long-term average.
“The market is getting more reactive to a lot of these negative headlines,” Lee said. “You can see that reflected through the VIX.”
Given the uncertainty, he said it’s important for advisors to closely monitor economic developments and adjust their clients’ portfolios accordingly.
In particular, he’s closely watching corporate earnings reports and developments in the European debt crisis for an indication of whether the first quarter rally in global stock markets is likely to continue.
“We’ll see how Q2 shapes up,” he said. “We think what happens in Q2 is going to dictate where markets move for the rest of the year.”
Despite the ongoing economic uncertainty, strategists at BMO Global Asset Management continue to be overweight on equities. Lee noted that fundamentals are strong and valuations are attractive, particularly on U.S. equities. However, he cautioned that markets are currently being driven by economic conditions more so than fundamentals.
Within the equity asset class, Lee currently favours sectors that are less cyclical and less volatile. “Even though we’re overweight equities right now, we are conservative in terms of our equity exposure,” he said.
He sees particularly strong opportunities in dividend-paying stocks, which are likely to continue benefiting from investors’ growing appetite for yield. “Screen for those companies that have a sustainable dividend yield,” he suggested.
Lee also urges advisors to consider consumer stocks, noting that the economic recovery in recent months has largely been driven by a rebound in consumer confidence.
Energy stocks also show promise, according to Lee. He expects the price of oil to remain elevated due to ongoing tensions in the Middle East, and he said this will benefit oilsands companies.
Fixed income has a “well deserved place in the portfolio”
Advisors should also embrace tactical strategies on the fixed income side of their clients’ portfolios, according to Mark Raes, portfolio manager at BMO Global Asset Management. He said the emergence of a multitude of fixed income ETFs – including ones that are segmented by term, credit and geography – has made a tactical approach to fixed income investing much more accessible to retail investors.
“You’re able to do the same sort of things now with fixed income that traditionally you might have associated with just equities,” he said.
Rather than having clients hold a fund with broad exposure to fixed income, Raes suggests tweaking clients’ exposure to different classes of bonds as market conditions change.
“If you start to segment by term, by credit, there’s a lot of opportunity to move around and make tactical investments.”
BMO Global Asset Management’s investment team is currently underweight on fixed income. However, Raes said there’s always a place for fixed income in client portfolios.
“You certainly don’t want to move away from fixed income,” said Raes. “Yes, yields are low. Yes, rates are low. But fixed income still has a well deserved place in the portfolio.”
Raes currently favours short-term and mid-term bonds, given the prospect of rising rates. “I would suggest underweighting on the long end,” he said.
He said there are also attractive opportunities in high yield bonds, which are yielding roughly 7% and have relatively low default rates due to strong corporate fundamentals.