Don’t marry your allocations – you may have to walk away from them

In the first of a new series of exclusive interviews for the Insurance Investment Exchange David Worsfold spoke to Con Keating, head of research at Brighton Rock Group.

Uncertainty swirls around the global economy and nowhere more so than in the UK. But amid all that uncertainty there are opportunities that insurance company chief investment officers should be focussing on, according to Keating.

Speaking in the middle of the General Election campaign, this lifelong Labour supporter acknowledged that “The biggest problem in the UK is Brexit. As it is foregone conclusion that the Tories will win we know Brexit will happen. That is not the end of it but the beginning of all the problems”.

However, before people wake up to the problems, it may create some short-term opportunities. There is reason to anticipate some uplift on returns as a Tory victory and a resolution of the immediate uncertainty over Brexit could boost the UK stock market: “It is a relative valuation market. If you look at the UK stock market now it is looking relatively cheap compared to elsewhere. A lot of that is down to the uncertainty of Brexit”.

This will be a short-lived window so pausing to reflect on the election result – assuming it is clear-cut – will not be a wise option: “It may be a case of sell in May and go away. There is no realistic prospect of concluding a new trade deal by the end of the year so if we need to extend the transition period we will have to apply to do that in June”.

This will be the time to start taking a longer term view as by then it will become clear that the overall effect of Brexit on the UK economy will be negative, says Keating. The outlook is not good for CIOs under pressure to boost returns and contribute more to the bottom line.

“We will see the end of the decline in gilt yields. They will start to drift higher. Arguably, that trend has already started as they bottomed out in July”.

With the stock market likely to be absorbing the negative impact of Brexit and gilts promising little, the conversation moved on to what options CIOs have for embracing a wider range of alternative assets.

Infrastructure has become fashionable, at least in discussions between fund managers and CIOs, and features heavily in government plans but it has drawbacks: “The problem for the coming year is that none of this is shovel ready”.

Infrastructure, along with other alternative assets coming on stream, might also fall foul of one of Keating’s other major concerns: illiquidity.

“I really don’t want to be making plans for the whole year now. I will be following events very closely and my advice to CIOs is be prepared to be fleet of foot. Make your allocations on the basis of what you see today but don’t marry them.

“What you shouldn’t be doing in the current environment is buy illiquid assets as the ability to re-organise your portfolio will be constricted”.

Where he does see opportunities is housing. He would definitely make housebuilders an exception to his adoption of the old mantra of selling in May. He urges CIOs to look at some of the housing bonds that are now available: “We will probably see more happening around housing. Because of the close link between house prices and inflation it almost becomes a proxy of inflation-linked bonds”.

There could be other opportunities coming out of the private sector too that deserve serious consideration.

At the global level one of the emerging issues in 2020 will be the future of cryptocurrencies.

“Will we see a specific proposal to create a digital currency by a central bank? It is still a slow burn. They do not yet have much impact as they are principally a vehicle for speculation. Once a central bank gets to grips with digital currencies then they will get serious”.

There are few central banks that could make a serious play to create a digital currency that would be widely used with the Fed and the European Central Bank along the most obvious candidates but by no means the only ones: “There is a lot of talk about it but I worry that the Chinese might get there first. They already have too much influence through initiatives such as Belt and Road. A Renminbi digital currency would have awesome power”, a view Keating offers as much as a warning as a prediction.

While digital currencies might produce some tech-related excitement, tech firms won’t: “What we are seeing is a slow deflation of the tech bubble. We will see much less willingness to take a leap into tech stocks or businesses that have been part of the tech boom – look at the problems firms like Uber and We Work are experiencing”.

ESG (environmental, social and governance) will rise up the agenda, however, and it will go beyond trying to meet narrow objectives: “We will see a lot more activity on ESG and it will affect the way firms are run. Colin Mayer’s work on corporate purpose (https://www.ft.com/content/786144bc-fc93-11e8-ac00-57a2a826423e) will have much more effect and one impact of that will be to lower corporate profitability”.
For the CIO looking for some additional geographical diversity in their portfolio, he steers them away from the political and economic turmoil of Latin America, the political volatility in the USA and the likely lack-lustre performance of most European economies, especially Germany. His choice might raise a few eyebrows.
“Africa looks good, especially on a ten year view. Everywhere I look I see growth. The population is still growing and is producing a demographic bonus. Many countries are leaving behind years of civil war and conflict and looking to develop their economies. There will be some great opportunities, especially in South Africa and some of the Mediterranean African countries”.
There is, he argues, a need for some fresh thinking: “We’re late cycle whatever way you look at it but with interest rates still exceptionally low it doesn’t quite look like the end of other cycles”.