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"We have been running a higher risk position in the portfolio since the end of the first quarter, given our negative outlook for fixed income markets in a tapering environment. Equity positions are the highest since inception in the portfolio. We have adopted tail risk hedges to offset this to a certain extent, which should limit drawdowns should markets fall more than 10%. This will mean that our short-term volatility might be higher, and could continue to be so, until fixed income markets normalise. Clearly, this could be a matter of months, or possibly a year or more. We feel this is the appropriate stance to take given the relative unattractiveness of fixed income investments. We are in abnormal times, with negative real yields still very much prevalent. We believe a focus on drawdowns rather than volatility during this period should resonate with our investors.

As we have said all along, we view the pick-up in the US, in the medium term, as a positive, which is why we are running such significant weightings in equities. The other major negative, a slowdown in China, is perhaps a positive. Many observers have felt that the new regime will simply shadow the old; however, they appear to be much more of a reforming ilk, and are now tackling the poor governance issues that have worried Western investors. Undoubtedly, this is likely to precipitate some short-term volatility as skeletons are aired, but ultimately, we believe a shake-up is good news, and we would look to add to Asia on weakness. The bottom line is that we remain nervous about the short-term direction of fixed income markets, and are not being adequately compensated for the risk taken. We would prefer to use our risk budget to increase our investment in equities. We expect defensive mega-caps to underperform over next 12 months; hence, our push into cyclicality, where we see more value."

David Coombs, Head of Multi-Manager Investments, Rathbones

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