Identifying opportunistic investments for enduring portfolios

Opportunistic investments beyond your core holdings may potentially enhance your risk-adjusted returns.

In Outlook 2018 , we made the case that a globally diversified multi-asset class portfolio should ideally form the core of your financial wealth. In Build an enduring global investment portfolio now , we present further evidence about why such a core portfolio should be held for the long-term. Global portfolios benefit from greater diversification and exposure to markets that have the potential to add returns to ‘home biased’ portfolios.

We also believe that global investment portfolios may benefit from more speculative opportunistic investments in order to seek enhanced risk-adjusted returns.We define ‘opportunistic investments’ as those that provide exposures to markets that may be mispriced or misunderstood, or that create exposures to structural and cyclical changes in markets, or new issuances.Depending upon a client’s investment objectives and risk tolerance,
for a medium risk portfolio, we estimate that up to 15% might be allocated to such opportunistic investments.In the following pages, we present five opportunistic
strategies of various timeframes and risks that
may be suitable for certain investors. We believe that global investment portfolios may benefit from more speculative opportunistic investments in order to seek enhanced
risk‑adjusted returns.Increase allocations to Chinese securitiesAsset class
Equities and fixed incomeHolding period
Long-term

We believe in the positive long-term outlook for China’s economy.
Economic reforms, improving capital investment discipline, and technological innovation may feed through into greater than expected Chinese financial market returns.
While Chinese equities and fixed income are equivalent to 16% and 9% of global capitalization respectively, their current weightings in major indices are significantly lower.
As MSCI and other benchmark providers increase China’s weightings this year, these are far short of actual representation and we expect international inflows into Chinese assets over time.
We see a range of possibilities for increasing long-term China allocations including direct holdings of securities and active managers.
Risk: If China retreated from its plans to open its financial markets to foreign investment, it would negatively impact our bullish case.

Invest in digital infrastructureAsset class
Equities, fixed income, and private equity
Holding period
Medium and long-term

Digital assets include data centers, wireless towers, small cell/fiber networks, automated warehouses and autonomous robots.
Digital data is proliferating: in 2017, 90% of the world’s data had been created in the previous two years.¹
Mobile data traffic is projected to grow sevenfold between 2016 and 2021, a compound annual growth rate of 46%.²
Data demand from artificial intelligence, cloud computing, and virtual reality are set to benefit the firms that develop, own, and operate real digital assets.
We see owners and operators of automated warehouses and manufacturers of autonomous robots as equity investments that have long-term outperformance potential.
We identify numerous potential beneficiaries among US and Chinese firms in technology services, infrastructure, e-commerce, in both public and private markets.
Risk: Producers backing the wrong technology standard and falling behind competitors would be negative for
returns.

Seek floating rate US dollar fixed income returnsAsset class
Fixed incomeHolding period
Short to medium term

Three-month US Libor is set to rise another 1% to 3.35% over the next 18 months based on the Federal Reserve’s projections.
As the Fed moves towards a late-stage policy tightening phase, we wish to overweight the front-end of the US Treasury yield curve, targeting attractive, low risk returns.
The current 3-month Libor rate is already 115 basis points above non-US developed market bond yields.
Add short-term money market instruments that approximate Libor with a small positive yield premium.
We also recommend higher risk floating rate instruments, such as high yield bank loan structures, and various structured products that may earn a larger premium rate above Libor, without the duration risk of bonds but with the additional risk to principal.
These yields may not be available in other currencies given hedging costs.
Risk: Were the Fed to cut US rates back to zero in a future recession, it would represent a key risk to our view.

Long Mexican peso volatility amidst political uncertaintyAsset class
Foreign exchangeHolding period
Short term

Mexico’s peso has been waxing and waning on trade‑related issues in recent months, weakening significantly once 10-year US bond yields rose to 3%.
While the currency looks undervalued, whether it can strengthen against the US dollar may depend on future Mexican economic policies.
Who wins July’s Mexican election islikely to determine the path of Mexican economic policy – see Robust strategies in a strongman’s world.
We favour buying cheap hedges for Mexican risk assets, which could be monetized quickly if they gained in value for any reason. This is timely, as peso implied volatility is low.
Risk: The Mexican election passing calmly without financial market impact would negatively impact this hedge.

Buy Eurozone cyclicals and banksAsset class
EquitiesHolding period
Medium term

The Eurozone’ economic recovery is much less maturee than the US expansion, but has lately experienced what we believe is a temporary growthscare.
While investor confidence has waned as a result of a sharp drop in positive economic data surprises, underlying forecasted growth over the coming year remains strong and intact.
On the ten previous occasions where the Economic Surprise Index was this depressed, Eurozone equities’ average return in the subsequent twelve months was 18.4%. There is no guarantee that the pattern will repeat itself or that the returns will be as robust.
Europe ex-UK dividend yields are 130 basis points above US dividend yields. The same firms pay 300 basis points less than US counterparts for their debt.
German exporters look particularly beaten down by US protectionism concerns, despite the trade dispute being largely confined to the US, China, and Mexico.
Eurozone banks trade at a price/book discount to US banks of more than 40% despite a very small difference in their returns on common equity.
While a full recovery in Eurozone banks may take longer than for trade fears to subside, regionalequities look ripe for a rebound.
Risk: An external shock hitting the Eurozone while
the ECB retreats from helping its most fragile governments would undermine

The investor must ascertain if they are suitable for each investment strategy based on their unique investment objectives and risk tolerances. Strategies discussed herein may have eligibility requirements that must be met prior to investing. Each investor should carefully view the risks associated with an investment and make a determination based upon the investor’s own particular circumstances, that the investment is consistent with the investor’s objective. Strategies described herein involve risk and may not perform as described.

International investing entails greater risk, as well as greater potential rewards compared to US investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economics.

Bonds are affected by a number of risks, including fluctuations in interest rates, credit risk and prepayment risk. In general, as prevailing interest rates rise, fixed income securities prices will fall. Bonds face credit risk if a decline in an issuer’s credit rating, or creditworthiness, causes a bond’s price to decline. High yield bonds are subject to additional risks such as increased risk of default and greater volatility because of the lower credit quality of the issues. Finally, bonds can be subject to prepayment risk. When interest rates fall, an issuer may choose to borrow money at a lower interest rate, while paying off its previously issued bonds. As a consequence, underlying bonds will lose the interest payments from the investment and will be forced to reinvest in a market where prevailing interest rates are lower than when the initial investment was made.

Currency RiskOne currency may decline in value versus another. The value of a multi-currency portfolio will fluctuate with exchange rates.