Within the core part of our balanced portfolio, we cover traditional liquid assets such as equities, fixed income and commodities. The chart shows how we would currently design a balanced portfolio, including alternative asset classes.2
Recent increases have already taken developed-market indices close to – or in some cases past – our 12-month strategic targets. Valuations appear to be at high levels, particularly in the United States, and this has added to fears about future volatility. Currency movements are likely to play a significant role in determining the direction of individual equity indices as well as investor returns across markets: any further policy initiatives by the Bank of Japan (BOJ) could, for example, have a positive effect on Japanese equities. Emerging-market equities may now find the going tougher as we approach a Fed rate rise. Within this sub-asset class we would favor Asia over Latin America.
Yields on core government bonds are likely to remain very low, despite signs of continued economic recovery in the Eurozone and some domestic pressures on the Fed to raise rates. In euro investment-grade credit, strong technicals and promised European Central Bank (ECB) action may drive spreads tighter in the near term. U.S. investment-grade credit should also gain from the latter factor, but in a less predictable way. The backdrop for euro high yield remains favorable, but U.S. high yield is likely to remain overshadowed by default concerns. Emerging-market hard-currency debt has done well recently, but we would suggest staying selective here.
Commodity prices have picked up on the back of a continuing recovery in oil prices and assistance (until recently) from a weaker U.S. dollar. Whilst we expect a further rise in oil prices on a 12-month horizon we are skeptical as to whether the overall commodities rally can be maintained in the medium term as it is not clear how many of them are really in short supply. In regard to oil, we expect prices will be supported over the long term by a gradual reduction in U.S. production and a gradual increase in global demand.