Your asset allocation guide – August 2014

After deciding that US equity market valuations are over-stretched, we’ve changed our asset allocation recommendations. In particular, we’ve decreased our exposure to international shares from over-weight to neutral and increased our cash weighting from neutral to overweight.

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After last month’s commentary about stretched valuations in equities and the Standard & Poor’s 500 Index in the United States hitting a fresh record high in late July, we’ve decided to trim our exposure to international shares back from an overweight position to a neutral weighting, with the proceeds used to increase our cash weighting from neutral to overweight.

Regionally, we still favour US equities over other developed markets, and the recent earnings season has confirmed that revenues and earnings in the United States are continuing to improve. About 75% of companies that have posted earnings this season beat analysts’ estimates for profit and 65% exceeded sales projections. On the other hand, in Europe, Russian economic sanctions and sluggish inflation are likely to temper corporate sales and earnings growth.

If global equity prices continue to fall on valuation and geopolitical concerns, as they did in late July and the early part of August, then there may be selective opportunities to re-weight portfolios away from European stocks to US stocks, while maintaining a neutral overall position.

Bond yields in many markets have continued to fall, and central banks in the United States, UK and Australia are warning that investors are attaching a very low probability to any rise in global interest rates, or any other adverse event.

For this reason, the higher weightings to cash, floating rate securities and tactical fixed income strategies remain our preferred defensive exposures for the time being.

We remain interested in selective high quality opportunities in the less liquid and less homogenous investment classes of property and alternative investments. Meanwhile, the higher weighting to cash is, in part, a place to park funds until opportunities in these asset classes emerge.

Our asset allocation summary:

Cash

still a preferred defensive asset, particularly relative to government bonds, and we suggest a slightly overweight position

Fixed income

preferred over cash and alternatives at present. Developed world government bonds are expensive so we prefer products with limited interest rate risk.

Australian equities

They remain underweight, with valuations somewhat stretched and growth lower than in other markets – meaning attractive opportunities in the Australian share market are harder to find. Hold positions in smaller companies but don’t add.

Property

Hold a neutral allocation to commercial property. The demand for core property is robust and rental growth fundamentals should improve.

International equities

Given higher valuations in developed market shares, reduce exposure to international shares to neutral weighting.  An unhedged allocation provides some protection if global growth disappoints as the currency is likely to decline. Emerging markets are relatively cheap so maintain exposure either directly or indirectly through the emerging markets earnings of global companies.

Alternatives

Maintain a neutral allocation until opportunities emerge.

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