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Asset allocation change and strategy

"We continue to run a higher risk position in our portfolios, given our positive view for economic growth and the relative attraction of equities versus other asset classes such as fixed income. Our equity allocations are the highest they have been since the inception of all of our strategies, and we maintain ‘tail risk’ hedges to help offset this risk and to help limit the potential for large drawdowns.

We have noticed that over the last 12 months, equity volatility has halved whereas bond market volatility has increased. This brings challenges for portfolio construction as the typically riskier asset classes (equities) have displayed ‘less risk’ over the short term and the typically less risky asset classes (bonds) have become ‘more risky’. Whilst we need to be aware of this development, we should be careful not to react to retrospective data and continue to look forward.

We believe our current positioning is appropriate given the backdrop of negative-to-neutral real yields. Although inflation pressures may be muted, the risk of inflation surprise is ever present. We believe a focus on correlations and the potential for drawdown, rather than volatility during this period, should resonate with our investors. In the short term, the volatility of our portfolios could continue to be higher, until fixed income markets normalise.

Investment outlook

With US Federal Reserve Chairman Bernanke postponing the start of the tapering program and the dovish Janet Yellen, set to succeed him, the prospect of higher interest rates still look to be 12 months away. This is not least because there remains significant debt in the system. Given this outcome and continuing positive data out of the US, we remain comfortable with a higher allocation to equities and an overweight to the US.

We are still constructive on the outlook for economic growth in Asia and Emerging Markets; however this will not necessarily translate into positive stock market performance. We are yet to see evidence of capital outflows stabilising. It remains difficult to purchase quality stocks in these markets at attractive valuations and so, on this basis, we will look to allocate selectively on dips to nimble managers with a proven ability to generate alpha. There is much noise coming from Japan which is difficult to analyse, so we remain neutral, but will closely monitor inflation and wages. We remain nervous about fixed income markets; it is difficult for investors to ascertain whether they are being adequately compensated for the risks taken. We are unlikely to increase equity exposures from current levels, but we may continue to rotate into cyclical areas of the market where there is more value."

David Coombs, Head of Multi-Manager Investments, Rathbones

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