FORSYTH PARTNERS ASSET ALLOCATION MODELS

By Forsyth Partners Limited

We feature a series of model portfolios with the intention of providing practical guidance for readers. It is updated and published quarterly.

The core portfolios are Global Equities, Global Bonds and Global Emerging Markets. In each of these we show the ‘FP Model Portfolios’ compared with major benchmark indices and an average of the positions of the leading fund managers.

Whilst we indicate specific percentage weightings, these should be used as broad guides and readers may wish to manage portfolios in a practical sense by considering exposure in terms of "ranges".

We divide the world into two broad groupings:

1. Developed Markets include North America, Japan, Continental Europe and the UK
2. Emerging Markets are featured on a regional basis to include South East Asia, Latin America and Emerging Europe, Africa & Middle East.

We also specify a number of portfolio variations based upon the core portfolios noted above. These include a series of Balanced Portfolios, a Positive Growth Portfolio and Currency Tilted Portfolios for Sterling, US Dollar and European investors who wish to retain a heavy proportion of their assets in their base currency. These portfolios are described from pure equity and balanced portfolio perspectives.

Last but not least we also feature performance information showing the results achieved. Please note, however, that the performance information is usually updated 1 month after release/publication of the asset allocation models.

GLOBAL EQUITY PORTFOLIO

Comment:

As noted later in our Global Review, we are not particularly well disposed to equity markets, at least in the near term. We would remind readers that the Global Equity Portfolio shown above will always be a fully invested model and, whilst we do not like equity markets, the weightings shown above provide a focus on the markets we dislike the least.

We believe that the safest haven will be the United States although we do expect a sell off from the current level of 7800 on the Dow Jones Index. Accordingly, we have boosted our weighting from 42.5% to 50%, moving almost in line with an MSCI neutral position. We retain our 5% Japanese exposure but we feel that the prospects for the UK are better than Continental Europe. Hence, we have cut the European weighting and boosted the UK. We have made a further cut in the Emerging Markets weighting and, now that this represents only 5% of the model, we would recommend that exposure be achieved through a global fund rather than through regional funds.

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GLOBAL BOND PORTFOLIO

Comment:

As noted later in our Global Review, we strongly prefer bonds over equities at present. With hindsight, our overweight position in emerging market bonds did us no favours in the last quarter. Going forward, particularly after the sell off and with yield spreads having widened significantly, we still retain a weighting although a more cautious one. As the prospects of reducing interest rates on a global basis are good, we have boosted our weightings in the core areas of the US, the UK and Continental Europe. Favoured currencies are found in countries with current accounts surpluses. We note that the global bond managers are actively managing currency exposure at present with the Deutschemark bloc currently being favoured.

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GLOBAL EMERGING MARKETS PORTFOLIO

There was certainly nowhere to hide in the last quarter in the Emerging Markets. Over the last year we have seen across the board falls in South East Asia, Latin America and Emerging Europe with the Russian influence having a major impact on the Eastern European markets. The Russian crisis also had a global impact and was perhaps the catalyst in awakening investors to the excesses in markets.

Going forward, the immediate issue is the problem in Brazil and the likely spin off effects into the rest of Latin America and the US. Our Global Emerging Markets Portfolio reflects this and we have reduced the Latin America weighting to 25%. We now reintroduce Asia at 25% of assets. We believe that the downside is limited but that immediate prospects for solid returns are not significant. Generally, as an asset class, we remain very cautious on emerging markets globally.

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BALANCED PORTFOLIOS

Comment:

The Balanced Portfolios have been constructed under three scenarios – 70/30 equity/bond, 50/50 equity/bond and 30/70 equity/bond. The purpose of providing three scenarios is to enable readers to choose the most appropriate model to select specific client risk profiles. The composition of the models flows directly from the Global Equity Portfolio and the Global Bond Portfolio. The figures show Q3 1998 weightings in parenthesis.

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POSITIVE EQUITY GROWTH PORTFOLIO

Comment:

The Positive Equity Growth Portfolio is intended for investors who wish to take a long term (5+ years) view. Over this time horizon we believe that it is reasonable to expect that equities will outperform bonds and that emerging markets should outperform developed markets although higher volatility levels will feature in the former. The composition of the models flows directly from the Global Equity Portfolio and the Global Emerging Markets Portfolio. The figures show Q3 1998 weightings in parenthesis.

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CURRENCY TILTED PORTFOLIOS

Comment:

The currency tilted portfolios recognise that many investors prefer to have a substantial proportion of their assets held in their home currency or country. The "Equity Only" portfolio above is constructed from the Global Equity Model. However, the figures reflect a 50% weighting in the home equity market before the Global Equity Model is applied. For example, in the US Dollar tilted model, the 75% weighting in US equities comprises a core weighting of 50% together with 50% of the 50% US exposure in the Global Equity Model.

The same principles are applied in structuring the "Balanced 50:50" portfolio. The method of determining the equity element is the same as that on the "Equity Only" portfolio. The bond content also follows the same principle, with a 50% weighting in the home bond market before the core Global Bond Model is applied.

We are showing in parenthesis the figures for Q3 1998.
 

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GLOBAL OVERVIEW

We continue to feature a Global Equity Portfolio, a Global Bond Portfolio and a Global Emerging Markets Portfolio as set out in schedules AA.1 - AA.3 of this document. In these core modules, we cannot clearly indicate any preference which we have towards a particular asset class. Our own disciplines dictate that we remain fully invested in the asset classes featured in the model portfolios.

In the case of the Equity portfolio, whilst we are concerned about the markets, we must be fully invested and have, therefore, taken what we believe to be a very cautious approach, one of emphasising the more liquid and developed US and UK markets at the expense of others. Balanced portfolios become much more important in difficult times like we are seeing at present.

Presently, we would tend to favour the most conservative of the Balanced Portfolios and would even probably go further in de-emphasising equities at the expense of bonds. It is too big a risk to exclude equities completely but in the short term we would strongly recommend a heavy bias towards bonds and cash. We have recently taken the view that the equity risk premium has risen substantially on a global basis and we now recommend a move in favour of bonds and cash as better investments in both relative and absolute terms.

It is easy to be a bear and many individuals have been late in arriving at the conclusion that the outlook is depressing but the trend is now firmly in place with only the US investor showing any meaningful resistance. AA.12 sets out a comparison of the events of 1929 with those of today. Gloom merchants emphasise the parallels but the background is different. Nevertheless, we anticipate a further fall in equity prices as the deleveraging process continues and investors flee from risk. Any asset which is overloved tends to falter and gains will be eroded where excesses are in evidence.

The levels of volatility which currently exist will only encourage investor inertia and we are acutely aware of the fact that most of the fund management groups to which we speak regularly are seeing, at best, no new inflows and, at worst, net outflows. The tide of liquidity has turned and is unlikely to return in the short term. Alan Greenspan and the US economy cannot bail out the world economy with interest rate cuts. Witness Japan, where effectively zero interest rates now act as a deterrent to the investor. The issues in Japan and core Europe are structural and will not be fixed by short term monetary easing. We are also concerned that the Euro is increasingly vulnerable as growth in Europe slows. At the extreme, even a realignment or a postponement could now be considered possible.

However, we cannot give credence to those bears who have joined the party and now predict the end of the world. The capitalist system remains in tact but remains vulnerable to excesses and declines. The scale of the downturn is becoming meaningful and we are approaching levels of valuations in selected markets that are appealing to the long-term investor. Bonds are still favoured, as inflation at the top of the cycle has remained muted and can be expected to fall as economic activity slows. Real yields have scope to fall even from these levels.

As noted earlier, we continue to favour the US, the UK and the European equity markets, in that order, but acknowledge that the US market is yet to make any significant move on the downside. Such a downward move would almost certainly lead to further falls in Europe. Timing is a major issue for most investors and we would argue that the balance of the year holds significant risks in relation to the potential rewards. As far as emerging markets are concerned, there will be opportunities for investors to make gains in the future. At this time of maximum pessimism, with liquidity squeezed, currencies under pressure and the politics looking awful, we need to be alert to any change in sentiment or fundamentals.

Our discussions with fund managers generally supports our contentions. Caution is the by-word. Undoubtedly, we may see markets bounce from these levels, but we should take care not to have a false sense of security under those circumstances. Our conclusion is that professional investors should overweight bonds and cash at the expense of equities. Equity portfolios should only focus on quality managers with an emphasis on blue chip shares.

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LESSONS FROM HISTORY

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PERFORMANCE REVIEW

This Performance Review for the Period Up to 31^st March 1998

Notes:

1. All figures calculated in US Dollars on a bid to bid basis with gross income reinvested.
2. Indices used are MSCI World, Salomon World Government Bond and MSCI Emerging World Index.
3. Performance data extracted for Hindsight; other calculations prepared by Forsyth Partners.
4. Figures calculated 1^st January 1998 to 31^st March 1998.
5. FP Model performance calculations are based on funds recommended for the first three months of 1998 on an equally weighted basis on specific recommendations by market as featured in this Asset Allocation Review.
6. Index performance calculations are based on: (i) in the case of equities, MSCI weightings adjusted for the performance of the domestic MSCI Index in the relevant market and (ii) in the case of bonds, Salomon World Government Bond Index performance.
7. Average Manager performance calculations are based on the Average Manager weightings at the beginning of each quarter, with the appropriate domestic MSCI or Salomon World Government Bond Index movement applied to these weightings.

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This document is issued by Forsyth Partners Limited, which is regulated in the conduct of investment business by IMRO. This extract from their research should be read in conjunction with the Methodology and Background Notes Module which forms part of the Research Manual which is published by Forsyth Partners Limited and is available on subscription and, in particular, attention is drawn to the emerging market risks warnings contained therein. The price of shares/units and the income from them can fall as well as rise and the value of an investment can vary upwards or downwards depending on exchange rate movements. © Forsyth Partners Limited – FORSYTH PARTNERS LTD, 18 BARCLAY ROAD, CROYDON, CRO 1JN UK.

Tel: +44 181 649 9440/Fax: + 44 181 649 9441