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 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.

Links to sections:
Global Overview, Market Commentaries - United States,  Japan, Continental Europe, United Kingdom, Emerging Markets - South East Asia, Latin America, Emerging Europe, Africa and the Middle East.

GLOBAL EQUITY PORTFOLIO

Comment:
The changes we have made to the model portfolios this quarter involve a further boost to the US weighting and an increase in exposure to emerging markets at the expense of Continental Europe. The new US weighting is in line with the MSCI benchmark but still remains well ahead of the average manager. Note, however, the significant boost in the US content of the average global equity portfolio. We still like the US market, both as a safe haven, but also as a reflection of the world’s growth engine.

At the beginning of Q1, we were bullish on Europe and on the Euro. This proved to be an error. In the near term, we believe that the Euro will remain weak and that the markets will trade sideways. Hence the reduction in our weighting. After much debate, we have maintained the Japanese weighting at 5%. A strong Yen normally leads to a weak market and vice versa. We believe that the markets of South East Asia will be beneficiaries of a strong Yen and hence the boost to emerging markets assets within in this region being favoured.

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GLOBAL EMERGING MARKETS PORTFOLIO

Comment:

His quarter we have boosted exposure to Latin America at the expense of the Emerging Europe, Africa and Middle East. We are leaving the South East Asian weighting unchanged. The South East Asian markets have had a quieter quarter after the strong rally in the last three months of 1998. We continue to believe that opportunities will be available selectively throughout the region. Emerging Europe is now less attractive with the escalation of the Kosovo crisis, although Russia is clearly benefiting from the recent strength of the oil price. We have increased the Latin American weighting partly as a reflection of this increase in oil prices with selective markets in the region clearly being beneficiaries.

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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 Portfolios. The figures show Q1 1999 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 Q1 1999 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, but now uses the currency perspective model portfolios.

We are showing in parenthesis the figures for Q1 1999.

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After the turbulent second half of 1998, stock and bond markets steadied somewhat in this, the first quarter of the year. The US market touched the 10,000 level on the Dow Jones Index and technology stocks were stunning performers. In Europe, after a strong start, The Euro came under pressure and markedly affected the performance of both European equity and bond markets. The Japanese market was slightly ahead in local currency terms but the Yen continued to be volatile with fund returns being influenced by hedging policies adopted by the managers. The UK market hit new highs and the small caps at last delivered some decent returns. In the emerging markets, Asia was steady over the quarter and Latin America made progress partly on the more positive outlook for the oil price. Emerging Europe presents an inconsistent picture. Russia, like Latin America, benefited from the oil price rise. The Southern European markets performed well until the Kosovo crisis heightened.

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UNITED STATES

As noted earlier the Dow Jones Index finally reached the 10,000 level and, at the time of publication has held above the barrier which was far from elusive. The market is ahead by 35% since the low point of last summer. Cash continues to flow into the market and the capitalisation of the US market now represents almost 54% of the world as measured by MSCI. The broader market, as measured by the S&P 500 Index, has enjoyed a buoyant quarter. The star performers, however, were the NASDAQ stocks. Some of the technology stocks showed huge gains and there seems to be no limit to the appetite of investors to participate in this sector. The focus on these stock is not confined to the retail investor. We continue to b surprised by the amount of so-called broadly based and even international funds which feature the popular hot stocks amongst their major positions.

On the earnings front, there have been some surprises but these have been shrugged off by the market. Valuations could be viewed as being unjustifiably high but investors remain comforted by good economic numbers. Mr Greenspan has been remarkably quiet in the last three months. Immediate fears over possible increases in US interest rates have abated but it is probably almost time for another statement from Greenspan about the valuation of financial assets which would certainly bring the interest rate issue to the fore once again.

International investors have been particularly well served by a high US equity weighting with the added kicker of a strong Dollar. This factor has also made US investors question the merits of investing outside their domestic market – adding further to the strong money flows on Wall Street. From a fund perspective, the growth managers continue to lead the pack. The selectivity in stock selection which we discussed in our Q1 review has not been relevant as yet. However, we continue to believe that any slow down in the US economy will benefit funds with a stock-picking bias.

JAPAN

It is increasingly difficult to reconcile the weaker domestic economy with the opportunities that are being presented by the micro-economic changes being forced upon many corporations in Japan. It is undoubtedly true that investors are increasingly concerned about maintaining a short position in the Japanese market, but failure of the real economy to show signs of recovery suggests that the upside for equities could be limited. The risk reward profile for the market is still difficult to determine and we feel that caution should prevail until the outlook for the economy is clarified.

Our analysis of global equity managers shows that in the last quarter the Japanese portfolio content of global equity funds has decreased to 8.5% (9.3% three months ago). Global bond managers have increased their global bond weighting to 5.4% (3.0%) but weightings lie significantly below the benchmark neutral position of 20.5% on the Salomon World Government Bond Benchmark.

After considerable debate we have decided to leave our Japanese weighting unchanged at 5%.

Recommended Weightings:

Equities in Global Equity Portfolio 5.0% (5.0%)

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It has been a difficult quarter for the continental European equity markets. The reception for the Euro was less than enthusiastic and the underlying weakness of the core economies in Europe has served to undermine the equity markets. The interest rate cut by the ECB is a sign of this weakness but in the medium term is likely to stimulate economic growth.

Our analysis of global equity managers shows that in the last quarter the Continental Europe portfolio content of global equity funds has decreased to 26.1% (28.2% three months ago). Global bond managers have marginally increased their Europe weighting to 38% (37.7%) and weightings lie slightly under the benchmark neutral position of 40% on the Salomon World Government Bond Benchmark.

We have decided to reduce our weighting in Continental Europe from 27.5% to 22.5% as we see better prospects in other markets.

Recommended Weightings:

Equities in Global Equity Portfolio 22.5% (27.5%)

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UNITED KINGDOM

The UK equity market has significantly outperformed its continental cousins over the quarter. And combination of easier monetary policy and the perception of a soft landing for the economy has encouraged investors to return to the market in earnest.

In terms of valuation and earnings profile the UK market remains relatively attractive within a global context.

Our analysis of global equity managers shows that in the last quarter the UK portfolio content of global equity funds has increased to 13.4% (11.4% three months ago). Global bond managers have reduced their UK Bond weighting to 8.5% (9.7% three months ago) but weightings lie well above the benchmark neutral position of 6.3% on the Salomon World Government Bond Index

Recommended Weightings:

Equities in Global Equity Portfolio 12.5% (12.5%)

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General Comments

Managers of emerging market funds, like those who focus on developed markets, fall broadly into two camps – those who are top down asset allocators and those who build their portfolios from the bottom up. The former begin with a selection process which involves determining what percentage of a portfolio should be devoted to each of the three emerging regions – South East Asia, Latin America and the group of countries comprising emerging Europe, Africa & the Middle East. The stock pickers on the other hand will focus on specific companies and will frequently point to the attractive relative valuations of equities in the emerging markets, compared to the equivalent companies in, say, Western Europe and North America.

There have been times in recent years when asset allocators have out-performed the stock pickers and vice versa. In the present environment, selectivity remains key. Many of the value driven players have turned in some excellent results of late and solid returns have been achieved, particularly through investment in South East Asia. Indeed those managers structuring portfolios from a top down perspective have also enjoyed success in that region, largely because of their over weight positions as they sought to avoid Latin America (because of the Brazilian problems and worries about the consequences for the region as a whole) and emerging Europe (because of the uncertainties following the Russian crisis). For most managers the Middle East and Africa are not yet seen as realistic investment candidates because of poor liquidity and a shortage of quality companies.

The rally in South East Asian markets in the Autumn and into the New Year came as a welcome relief. Many managers joined the bandwagon as it rolled along. Those who were in early did well. Some however were late in arriving and almost missed the party. After recent strength in Asia, with currency gains also making positive contributions to performance, the question is "what now?" Our discussions with fund managers and our own experience in managing global emerging market portfolios indicate that selectivity will be the key and that simple regional asset allocation, without regard to the relative attractions of different countries will not be successful.

Let’s look at the forgotten emerging market of India. Following the recent Budget, the Indian stock market has been a strong performer, as confidence has returned in what is seen to be a much more friendly environment for corporates. We like the Indian market and, in particular, the IT sector, which has been driven by foreign recognition of some excellent companies, as well as by the general upswing in tech stocks on Wall Street. Elsewhere in Asia it is the restructuring stories which need to be looked at. Sorting the wheat from the chaff is the skill. Favoured areas here include Korea and across the region as a whole, the banking sector.

The firmer oil price points us to look more positively towards Latin America, particularly to those countries whose economies are dependent on the price of oil. However, liquidity considerations drive us to favour Brazil and Mexico.

In emerging Europe the interesting theme is the Euro convergence opportunity for Greece and Poland. Greek bonds and equities have produced excellent results of late.

Finally to revisit Russia, the movement in the oil price is helping the market and Russian securities have forged ahead this year. Even the bonds which had been so discredited have enjoyed a rally. We have noticed a strong upsurge in the Russian weighting of the emerging European regional funds. The average weighting now lies in the 10% region, having doubled recently but still far below the 35% levels we saw in July last year. The current weighting build-up is akin to that seen in 1997. Diverse attractions lie across the globe – they are not limited to any one region. The key will be to remain flexible and to adopt an active and opportunistic approach. As we have increased the Emerging Market Weighting in the Global Equity Model, it may be appropriate to consider using regional funds rather than a global fund to effect the strategy.

Recommended Weightings:

Equities in Global Equity Portfolio 7.5% (5.0%)

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SOUTH EAST ASIA

Recommended Weightings:

Equities in Global Emerging Markets Portfolio 40.0% (40.0%)                 

LATIN AMERICA

Recommended Weightings:

Equities in Global Emerging Markets Portfolio 35.0% (25.0%)

Recommended Weightings:

Equities in Global Emerging Markets Portfolio 25.0% (35.0%)

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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.

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