John Ventre, Skandia Shield Portfolio Manager – Skandia Investment Group writes:
As of 21st February, the Skandia Shield Portfolio has been rebalanced to reflect updated market volatility and correlation and current market views. The optimal portfolio when both of these factors are incorporated has a volatility slightly over the 8% target. Volatility in equity markets has faded substantially. The fund used a little leverage between the January and February rebalancing points, reflecting the negative correlation and strong diversification between government bonds and equities. Due to this correlation breaking down a little over the course of February and the lower allocations to government bonds which the portfolio has this month, this has reversed, with a little cash now being used. Government bonds remain extremely unattractive from a return perspective with significantly negative yields in real terms being seen to 2021 and beyond. Nevertheless, in the short term there looks to be little in the way of catalyst for yields to move higher. Holding some government bonds allows the portfolio to hold more equities and still meet the volatility target.
The optimal portfolio has been derived using the following views:
Equities are expected to outperform Corporate Bonds
Equities are very good value. Markets look to have "priced in" at least a strong probability of a return to significant recessionary conditions despite this conclusion not supported by the economic data (other than in Europe where a mild recession now looks likely). European policy has failed to adequately address the gathering storm in sovereign credit markets with policymakers in the Eurozone consistently providing too little policy response too late. Nevertheless, investors look to be more than well compensated for taking this risk given current equity prices.
European equities and UK equities are expected to outperform other developed markets
The sell off in European stocks looks overdone, with valuations now at compelling levels. While UK valuations are less compelling, there is also less macro risk. Both are attractive.
Emerging market equities are expected to outperform other equity markets
Emerging market stocks have underperformed developed markets over the last year as fears of interest rate rises and rising inflation began to dominate sentiment. There remains a strong valuation argument for emerging markets. For example, Chinese equities have a much lower 2011 forecast price earnings multiple as US equities but the growth prospects in China are much stronger. As monetary policy begins to loosen in emerging economies, this should provide the catalyst for a re-rating.
Russian equities are expected to underperform other emerging equity markets
Political unrest in Russia remains a risk with recent elections proving indecisive. Uncertainty is likely to continue in the coming months ahead of presidential elections next year. Russian equities are very cheap, being at valuation levels last seen during the 1998 default, however they look likely to remain cheap whilst there is so little political certainty.