Sipp Investor: my major shift to emerging markets

Former economist and fund manager Rob Kyprianou has made some big changes to the holdings in his Sipp (self-invested personal pension). He explains why.

Set against a background of troubles in North Africa and the Middle East, financial markets started March with a continued rotation of funds out of emerging markets, were then rocked by natural disasters in Japan and ended with growing speculation that official interest rates in the West would start going up soon, starting with the European Central Bank (ECB). This was a month full of volatility, traps and new uncertainties.

Over the month, my portfolio performed well during all this noise. Having sat out and suffered from the rotation into developed markets in January and February, this trend reversed as I argued might happen in my last article. As a result my portfolio rose by 2.3% while my benchmark (see previous articles) fell by 0.5%. The main drivers for this outperformance were the recovery of (mainly Asian) emerging markets, while developed markets were rocked by events in Japan and by growing expectations of interest rate rises in the West.

Major move

March saw the first major activity in my self-invested personal pension (Sipp) portfolio this year. As signalled in my last article, I felt the rotation into developed markets would come to an end in the face of growing pressure for official interest hikes in Europe and the US. I began a programme of selling developed equity markets holdings and increasing even further my exposure to emerging equity markets. I had planned to sell holdings in the UK and the US (I hold no Euro equities), but following the earthquake, I held off US sales and sold all my Japanese holdings instead.  

The funds I sold were Invesco Perpetual Japan , GLG Japan Core Alpha and Jupiter UK Growth and Income . The funds I bought were three First State funds - Asia Pacific Leaders , Greater China Growth and Global Emerging Markets - as well as Aberdeen’s Global Emerging Market fund.

Strategy remains the same

Although Japan’s crisis hit equity markets, the natural disaster only affected my tactics and not my strategy. Over the years of investing in financial markets I have come to understand that it is excessive financial speculation that permanently destroys wealth rather than natural disasters. For example, the tech boom in the 1990s, the Japanese property and equity boom of the 1980s and the recent sub-prime mortgage bubble have led to serious and permanent losses of wealth.

In contrast, natural disasters, however terrible they are to witness and experience, add volatility and may affect some local relative value plays. The volatility can be exploited if the event is not fundamental to one’s strategic view. In such circumstances, when all markets take a sentiment-driven hit, it is normally an opportunity for the objective investor. Consequently, the volatility around the earthquake/tsunami gave me opportunities for better market timing of my sales and purchases which added to my performance in the month.

My holdings

At the end of the month the cash holdings in my Sipp remained at the 10% level, with my holdings in emerging market funds up to 33%, and in developed market equities – UK and US only now – down to 34%. The rest is in global themes such as financials and natural resources (18%), and in index linked UK bonds (5%).

With western developed markets close to their pre- Earthquake/tsunami levels we can again concentrate on the key strategic themes. These have not changed through March’s noise. The debate over the timing of interest rate rises in the West gathers steam with the ECB signalling the turn in rates with their first move in early April; the emerging markets continue to provide the growth momentum and, where there has been overheating as in China and India, their policy makers are well advanced in dealing with the pressures; Europe continues to paper over the cracks in terms of dealing with sovereign insolvency in periphery countries; the private sector in the West (outside of periphery Europe) continues to provide the only game in town, supporting corporate profits growth and helping to absorb some of the resources freed by financially crippled public sectors; and the once crippled western banks continue on their road to repair, although some of the worst affected, such as in Ireland, will need more bail out capital.

Higher interest rates

The key theme in the next few months will be the normalisation of yield curves – short term and long term interest rates – in key western economies. The record low yield structure that emerged from the embers of the financial crisis of 2008 was appropriate for a time of near collapse in financial and economic systems. That time is behind us and we are now in a phase of healing and recovery in the West. This will take some further time before public sector finances are restored to a position where the public sector is no longer a drag on the economy and before banks are fully recapitalised and ready to lend with vigour once again. However, the worst of the crisis is over and the debate growing within the central banks of Europe and the US is about how and when to return to a level of rates that reflects the new reality of modest growth and some inflation, as opposed to depression and deflation.

Europe ahead of the pack

The ECB has stolen a march on the Bank of England and the Federal Reserve, effectively saying that the problems of the insolvent periphery Euro countries cannot be dealt with by normal economic policy instruments such as central bank rates. The only solution for these countries is some form of debt forgiveness, a solution towards which the countries of the Euro are not moving on a coordinated path.

The Federal Reserve and the Bank of England will follow as more voting members of both boards realise they are playing a dangerous game keeping rates artificially low for so long.