Manager Insight

Valuations and growth prospects are more attractive than in the U.S., manager says.
By Michael Ryval | 25/05/17

Market conditions have become challenging as valuations are stretched and, worryingly, there is a higher degree of complacency than is usually the case, says Greg Nott, chief investment officer at Toronto-based Russell Investments Canada Ltd. Among his roles is managing the $154-million Multi-Asset Growth Strategy, (or MAGS as it's called).

About the Author
Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

Part of a suite of multi-asset solutions, MAGS combines a long-term strategic asset allocation with a tactical element. Its objective is to achieve a long-term annualized return of 7%, or a blend of 2% inflation plus 5% real return. The fund's strategic asset allocation is a mix of 75% equities and 25% fixed income.

To determine the asset mix, Nott relies on input from a half-dozen strategists in the Russell Investments organization around the world. As of late April, the tactical allocation was a more defensive one with about 67% in equities and real assets and 33% in fixed income and cash.

"We look at asset classes in terms of three components: cycle, valuation and sentiment," says Nott, a 22-year industry veteran who joined Russell Investments in 1998. "In the U.S., we have a concern about the economic and earnings cycle starting to slow a bit. It's all trending a little bit lower. There was disappointing GDP growth in the first quarter and the anticipated fiscal spending seems to be delayed. And the Federal Reserve is clearly in a hiking mode. To us, that leads to slowing in the U.S."

From a valuation perspective, Nott says U.S. stocks are very expensive on a historical and relative basis. "It's not like in the dot-com bubble. But if you look at price-earnings ratios along with other valuation metrics, however, they are on the higher end," says Nott, adding that stocks in Europe and emerging markets are more attractive. "There are also technical factors, such as moving averages, and they are all on the high side," says Nott. "Put this all together, and it causes us to lean away from U.S. equities."

Nott leans more toward European equities because the European Central Bank is still pursuing a monetary-easing program, the economic cycle looks good and growth is accelerating. "Sentiment has been more negative because of the political risks," admits Nott. "We think those fears are overdone and that has suppressed valuations, which are lower than in the U.S. But overall, at the total portfolio level we are somewhat defensively positioned because global markets are expensive."

Nott admits to being cautious about the Trump administration's growth-oriented policies, and notes that since mid-February the bond market has been rallying, on falling yields. "The bond market is being somewhat skeptical about the timing and the magnitude of these polices. We're seeing the same in currency markets as the U.S. dollar has weakened against a trade-weighted basket of currencies. Equity markets are not so skeptical -- at least not yet. That's why we are more cautious on equities because there is the potential for disappointment."

MAGS is a fund of funds that holds a mix of up to 50 different Russell specialty funds that span a full range of asset classes. From an equity standpoint, the portfolio is underweight in the U.S., and overweight in Europe, Japan and emerging markets. There is also 16% in so-called real assets, such as listed real estate.

Nott believes that U.S. growth in 2017 may be around 2%, and below consensus estimates. "We believe that the Federal Reserve is only going to hike one more time, and not two as some expect. We are also a little below consensus on earnings growth in the U.S. When it comes to Europe, we expect 1.5% GDP growth, but it's improving and we see better earnings growth there. And the business cycle is in pretty good shape." Nott expects that China will achieve a so-called soft landing as growth is gradually slowing.

Like others on a team of nine portfolio managers and analysts, Nott relies on a proprietary checklist that gives scores to a slew of global equity and fixed-income markets. For example, on a qualitative and quantitative basis, the U.S. gets a slightly negative score. In contrast, emerging-markets bonds get a slightly positive score. While Nott looks after the Canadian products, colleagues in other Russell Investments offices apply the same process to the funds in the multi-asset solutions sold in their markets.

More important, MAGS is run on an absolute basis and unlike benchmarked products. "The fund is different from its peers because it has a different objective. There is no category for these outcome-oriented products, such as ours. But we're quite happy with the one-year return, given what we're trying to achieve," says Nott. "We are more than achieving our return target with less than two-thirds of the volatility because we're defensively positioned. It's like the tortoise and the hare. We're plugging along, focusing on long-term capital growth while minimizing the draw-downs."

Meanwhile, Nott is preparing for the possibility of an equity market pullback should Trump's policies go unfulfilled. "We are not expecting a recession. Bear markets are driven by recession, and there are very low odds of a recession in North America over the next 12 to 24 months," he says. "But an 8% to 12% pullback in equity markets would be a buying opportunity."

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