Vasu Menon of OCBC Bank explains the need for greater diversification as a way to deal with the uncertainty and volatility which are now part of financial markets today.
Date: Oct 2011
Tags: Volatility, Diversification, Asset allocation, Equities, Bonds, Commodities, Cash
And unless politicians in the US and Europe can address some of the deep-rooted structural problems, he said there will be a lot more turbulence going forward.
For investors, Menon said irrationality can be their biggest enemy. Yet being in cash is not the best thing to do, he added.
While there is a good reason for investors to be cautious, they need to recognise the fact that the market is not expensive at this point in time, especially the equity market, he explained. So investors should drip-feed into the markets and stagger their purchases over the next 12 to 18 months, not try to time the markets.
As a result, asset allocation and diversification are key at this point time, said Menon.
How to diversify
If an investor has, for example, US$180,000 to invest in the markets, Menon said he would recommend they spread this over the next 18 months or so, for instance at the rate of US$10,000 a month.
He said he thinks equities are still the way to go, and even through the economy is still suffering, equity markets are cheap, so for anyone with appetite for risk, an allocation of 60% to 70% in equities makes sense, especially for those with a longer time horizon, he explained.
Menon added that investors shouldn’t ignore the bond market, especially for a diversified portfolio. From a starting point of asset allocation, investors should have at least 10% to 20% of their money invested in bonds, he said.
He said there are good opportunities in Asian bond markets, despite a recent pull-back because of the outflow of capital from this region due to risk aversion. But he said he thinks Asian fundamentals are good.
Investors should also be looking at commodities for the medium term, he added, regardless of recent downturns.
Prioritising equities and bonds
For Asian investors, Menon said they should look first at local opportunities in equities and bonds, given that the region is likely to outperform the rest of the world in terms of economic growth.
The 1997 Asian Financial Crisis was a blessing in disguise, he explained, given that it helped governments, companies and individuals get in better shape and more prepared. Now, valuations in Asia are inexpensive, and domestic companies are starting to embrace corporate governance and pay out better dividends, yet the region is under-represented in global portfolios, said Menon.
As a result, he said he thinks global investors will increasingly see the potential of Asia over the next five years. More money will then be allocated to these markets. Also, given that there is less liquidity, a greater asset allocation to Asia will result in the markets heading higher.
In terms of bond markets, while Asia is not as developed as the G7 bond markets, Menon said governments are putting effort into broadening their capital markets, especially the bond markets, because they see this as a way to raise revenue.
Cash as an option
In the short term, while Menon said it makes sense for investors to hold a disproportionate amount in cash, returns are very low.
Plus, equity valuations are not expensive, and even if they get cheaper, especially with the sentiment of the market, investors should take a longer-term view given current buying opportunities.
According to Menon, volatility is going to be a fixture of markets going forward, with the world entering a “new normal”. Growth won’t return to the heydays of 2005 to 2007, he added.
Menon said investors therefore have to manage their expectations in this new environment, meaning they have to be more realistic, and not think they can make 30% to 40% returns on an annual basis over the long term.
