A look at 2013 and beyond

Using credit as your primary asset class in your investment strategy in 2012 would have produced some very attractive high single digit or low double digit returns. The extent of such returns would have been dependent on a number of factors such as credit rating, industry exposure, duration, and currency exposure. Looking forward to 2013, does such an investment strategy need tweaking or a complete overhaul?

If one has the necessary skill set, then 2013 may be approached with a cautious degree of enthusiasm- Karl Micallef

Traditionally, in the investment world, answers to such questions start with the words ‘it depends’ – and this question is no exception. In this case the answer depends on your economic outlook. It depends on what one expects to happen in the various continents and, furthermore, how the market will react if those expectations were to materialise.

Going forward, it would be very difficult to argue that a complete overhaul is due. This could mean that exposure to credit, being currently used as an asset class within a total return investment mandate, would form a very small part of the overall strategic asset allocation.

One must be very bullish on the macroeconomic outlook to reach such a conclusion, a comfort level I have not yet reached. However, it does seem like equity, as a separate asset class, can be attributed a higher weighting in next year’s investment strategy. I would reach such a conclusion from two separate angles. Firstly, there are a number of instances in which specific blue chip companies are trading on dividend yields which, in absolute terms, make them hard to go unnoticed.

Furthermore, on a relative basis, these dividend yields have become even more rewarding given the recent market rally in credit. Secondly, if your base assumption is that we are approaching 2013 with arguably less event risk than a year ago, then one can cautiously argue in favour of partially shifting risk capital out of credit and into equity.

During the second half of this year, we witnessed a growing number of companies raising capital through credit to buy back their own equity with the proceeds. This action could be a reflection of a number of strategic corporate decisions. As a start it could be that the directors of the company believe they can reduce their cost of capital by increasing credit and reducing equity (the latter typically being a more expensive class of capital).

Alternatively, the company may deem that the market is not pricing the company’s equity correctly (on the downside) and hence see an opportunity in buying the company’s own shares at a price which is lower than what the company itself perceives to be the correct value. It is often said that the market is never as well informed as the directors of a company no matter how much research is carried out. This is frequently the case, and hence apportion a lot of attention to such corporate action.

On the other hand, there are still a number of risks still present – real risks which can change the perceived improvement in the global economic outlook in a second. A current example of such a scenario can be witnessed on the political front in Italy. It is specifically because of such scenarios that I remain very cautious on the level of risk one should introduce or increase in their portfolios.

In addition to asset allocation, 2013 will be a year where specific stock selection will be very important. If we were to look at 2012, having the right asset type in place was enough to generate the returns quoted earlier. To a certain extent these past 12 months have been kind to investors from an investment point of view.

In the next year and beyond we will witness an investment market which will be very rewarding to those who can stock pick the right line items within the predetermined asset classes. It will be a more difficult market place to generate similar returns to those experienced this year – but if one has the necessary skill set, then 2013 may be approached with a cautious degree of enthusiasm.

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Curmi & Partners Ltd is a member of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business. This article is the objective and independent opinion of the author. The value of investments may fall as well as rise and past performance is no guarantee of future performance.

Karl Micallef is an executive director at Curmi and Partners Ltd.