ETF Securities underweights equities on heightened political risk

Feb 15th, 2017 | By | Category: ETF and Index News

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London-based ETF Securities has stated that political risks in the US and Europe are rising and will last longer than the market is currently pricing in. Uncertainty surrounding Trump, Brexit and the forthcoming elections in France, Holland and Germany are key factors behind the continued underweighting of equity in their tactical portfolio.

Edith Southammakosane, Director – Multi-Asset Strategy

The ETF Securities tactical portfolio is designed to outperform the strategic benchmark by applying fundamental based models to reflect ETF Securities’ views of the global economy and each asset class. The portfolio is currently weighted 45%, 35% and 10% to equities, bonds and commodities respectively. The strategic benchmark is a balanced portfolio weighted 55%, 35%, 10% to equities, bonds and commodities respectively, with each asset class tracking a broad global benchmark index.

Edith Southammakosane, Director of Multi-Asset Strategies points out that while many of Trump’s election pledges are unlikely to become reality, he might not be the trade partner the UK is looking for, as so far his administration is loosely delivering on what was promised during his campaign. Southammakosane goes on to say that in addition to political uncertainty, inflation growth in the US, EU and UK increases the risk of central bank errors as they are forced to make difficult decisions as the process towards monetary policy normalisation tentatively continues.

Within the equity space, the ETF Securities tactical portfolio is currently underweight in US, France, Italy, Denmark and Sweden, while overweighting equity in Brazil, Russia, India, Turkey and Canada. The tactical portfolio allocates equity weights based on the cyclically adjusted price-earnings ratio (CAPE), attempting to overweight regions that are undervalued according to their long-term CAPE average, and underweight those that are overvalued. The US CAPE ratio currently stands at its highest level since December 2014 and 47% above its 10-year average. In January, the French CAPE ratio reached its highest level since 2007 before declining slightly in February. At the other end of the spectrum, Brazil and Russia continue to show the largest differentials between their CAPE ratios and their respective 10-year averages, suggesting these countries remain largely undervalued.

According to ETF Securities, the tactical portfolio is overweight bonds relative to the strategic benchmark portfolio, but within the asset class, bond weighting is now neutral, in line with that of the strategic portfolio. This marks a change since the end of 2016 when all bond categories were underweight except US investment grade on the back of inflation and interest rate expectations in the US and Europe. Southammakosane adds that the CDS (credit default swap) of both US and EU bonds are hovering around their historical averages which confirm the neutral position of the tactical portfolio.

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