Tactical Asset Allocation Change

Transcription

1 april 14, 2011 research bulletin global investment committee Global Investment Committee Tactical Asset Allocation Change analysis authors Equities: Increase Exposure to US Stocks and Reduce Exposure to Canada and Asia Pacific ex Japan Stocks Bonds: Increase Exposure to Emerging Market Bonds and Reduce Exposure to Developed- Market Government Bonds jeff applegate Chief Investment Officer david m. darst, cfa Chief Investment Strategist kevin flanagan Chief Fixed Income Strategist jonathan mackay Senior Credit Strategist charles reinhard Deputy Chief Investment Officer douglas schindewolf Director of Tactical Asset Allocation

2 Summary of Strategic & Tactical Allocations for Global Investment Committee Asset Allocation Models The table below summarizes our best thinking on the construction of strategic portfolios and tactical asset allocation. These three portfolios are a sampling of our guidance for investors with more than $20 million of investable assets, which are a subset of the GIC asset allocation models that are shown starting on page 6. The strategic equity allocations in these portfolios are in proportion to their share of global market capitalization. Recent changes are marked by arrows. effective april 15, 2011 Model Source: Global Investment Committee as of April 15, 2011 Moderate Balanced Strategic Weight Tactical Relative Weight Equity & Alternative Investments Strategic Weight Tactical Relative Weight Bond & Alternative Investment Strategic Weight Tactical Relative Weight Global Cash 5% -2% 0% 0% 25% -2% Global Equities Global Alternative/Absolute Return Investments Global Cash Investment Grade Short Duration Government/Government-Related Corporate & Securitized High Yield Emerging Markets Total Bonds Total Cash & Short Duration Bonds Global Equities US Large Growth Value US Mid Growth Value Canada Europe Europe ex UK UK Developed Asia Japan Asia Pacific ex Japan US Small Growth Value World ex US Small Cap Emerging Markets Total Equities US Equity Developed World ex US Developed Market Equity Emerging Market Equity Global Alternative/Absolute Return Investments REITs Commodities Inflation-Linked Securities Managed Futures Funds Hedge Funds Private Real Estate Private Equity Total Alternative/Absolute Return Investments morgan stanley smith barney april 14, 2011

3 Global Equities: Within Developed Markets, Small Shift to US From Non US Since April 2009, within the context of an equity overweight vis-à-vis bonds and cash, we have been overweight (OW) emerging markets and underweight (UW) developed-market (DM) equities. Within DM equities, our biggest UW has been Japan, followed by Europe; our only OWs to DM equities have been Canada and Asia Pacific ex-japan, with Australia primarily constituting the latter. Since January 2011, we have been market weight (MW) US equities. Today we are dropping to a MW for Canada and Australia and redeploying those funds to an OW in US equities. WANING TAILWINDS. Our rationale for our OWs to Canada and Australia was twofold: commodity exposure and currency appreciation. Both countries have a disproportionate exposure to commodities energy in Canada and mining/raw materials in Australia which we generally have expected to continue to perform well alongside the ongoing global businesscycle expansion and with the leading role commodity-hungry emerging economies play in that growth. As for currency, we expected that both the Aussie and Canadian dollars would trade at least at parity with the US dollar. Given that we manage global equities on an unhedged basis for mainly US-dollar investors, we thought that currency appreciation would provide an additional boost to those local equity returns. In the one-year period ended March 31, 2011, the MSCI Canada Index Chart 1: Big Caps are more attractively valued than mid caps Ratio: Russell Mid-Cap FPE to Russell Top 200 FPE and the MSCI Australia Index returned 23.1% and 15.0%, respectively, in US-dollar terms. Both markets outperformed, in US-dollar terms, the global benchmark MSCI All Country World Index s 14.6%. Now that the Canadian and Australian currency appreciation we were looking for has largely occurred and in the case of Canada, begun to abate only one rationale for overweighting those stock As compared with the forward price/ earnings (FPE) ratio of the Russell Top 200 Index, the FPE ratio of the Russell 800 Index reveals the largest US stocks to be relatively inexpensive. Average Source: Thomson Financial, FactSet Research System as of March 31, 2011 Table 1: Morgan Stanley and Citi Global GDP and Inflation Forecasts (year-over-year percent change) % Contribution Morgan Stanley to Growth 2010E 2011E 2012E 2011E Global GDP Developed Economies US Euro Zone UK Japan Developing Economies Brazil Russia India China Global Consumer Prices Global Inflation Developed Economies Developing Economies US Core US CPI % Contribution Citi to Growth 2010E 2011E 2012E 2011E Global GDP Developed Economies US Euro Zone UK Japan Developing Economies Brazil Russia India China Global Consumer Prices Global Inflation Developed Economies Developing Economies US Core US CPI Note: Morgan Stanley regional and global forecasts are GDP-weighted averages, using Purchasing Power Parity estimates. That gives greater weights to developing economies. Citi forecasts use current foreign exchange rates. Source: Morgan Stanley & Co. Inc., Citi Investment Research & Analysis, Morgan Stanley Smith Barney as of April 8, morgan stanley smith barney april 14, 2011

4 markets remains: commodities. Since we already have an OW to commodities as an alternative asset class, playing the commodity trade indirectly through those equity markets is not compelling. Accordingly, we are moving to MW from OW for Canadian and Australian equities. The policy response to the financial crisis was more robust in the US as compared with Europe or Japan. Thus the business-cycle expansion in the US will likely continue to be stronger than in Europe or Japan (Table 1). Moreover, US monetary policy discussed in greater detail below remains more stimulative than European or Japanese monetary policy. Finally, given that 55% of US, European and Japanese stock market profits are sourced locally, we decided to move to OW US equities from MW. TARGETING US MEGA CAPS. Within US equities, we have opted to add to our large-cap exposure. As compared with the forward price/earnings (FPE) ratio of the Russell Top 200 Index (the index we use to represent mega-cap stocks in the US), the FPE ratios of the Russell 800 and Russell 2000 indexes (the indexes we use to represent mid-caps and small-cap US stocks) reveal the largest US stocks to be relatively inexpensive. Indeed, the levels of these FPE-ratio comparisons are extreme by historical standards (Charts 1 and 2). As a result of this change, our tactical allocations now indicate a preference for large caps at the capitalization level. We retain our preference for growth over value at the style level, as relative valuation continues to suggest that value stocks are expensive relative to growth stocks, especially in the large-cap sector. For example, at 0.87, the ratio of the FPE on the Russell 1000 Value Index is nearly two standard deviations above its longterm average of 0.70 (Chart 3). Fixed Income: Small Shift to Emerging Market Debt From Developed-Market Sovereigns THE EASY MONEY EXIT. The altered landscape within the developed world s economies, their fiscal positions and attendant monetary policy outlooks present a challenging environment for Chart 2: And big caps are more attractively valued than small caps Russell 2000 PE to Russell Top 200 PE developed-market (DM) sovereign debt in the months ahead. Concern about renewed economic slowing and potential double dips have given way to a more sustained expansion accompanied by rising inflation expectations. Against this backdrop, the DM money and bond markets are confronting the beginning stages of the long-awaited exit process. Inflation rates are running above target in both the Euro Zone and the UK, leading to the possibility of a series of rate hikes from their respective central banks. In the US, the scheduled June 30 Comparing the forward price/earnings (FPE) ratio of the Russell Top 200 Index with that of the Russell 2000 Index shows that this FPE-ratio comparison, too, is extreme by historical standards. Average Source: Thomson Financial, FactSet Research System as of March 31, 2011 Chart 3: Growth is more attractively valued than value Relative valuation continues to suggest that value stocks are expensive relative to growth stocks, especially in the large-cap stocks. For example, at 0.87, the ratio of the FPE on the Russell 1000 Value Index is nearly two standard deviations above its long-term average of Russell 1000 Value FPE to Russell 1000 Growth FPE Average Source: Citigroup Global Markets, Inc., FactSet Research System as of April 7, 2011 end of the second round of Quantitative Ease (QE2) is drawing nearer, which will most likely usher in the early stages of discounting the Fed s own exit strategy. Our base-case assumption is that there will not be a cliff effect in the Treasury market once QE2 concludes, but we do anticipate a gradual backup in rates along the yield curve. We expect the yield on the US 10-year Treasury note to climb into the 3.75%-to-4% range over the next 12 months. This could begin as the Fed steps away from active Treasury buying and market participants continue to 4 morgan stanley smith barney april 14, 2011

5 discount the economic expansion. We expect market rates to rise well before a hike in the fed funds target rate, which is unlikely before CONDITIONS RIPE FOR EM BONDS. The outlook for emerging market (EM) debt markets differs from that of the industrialized markets. With economic growth continuing at more than twice the rate of the major developed countries, monetary policy will probably tighten further, currencies are likely to appreciate and improving sovereign-credit risk profiles should mean somewhat flatter yield curves. One caveat is that returns on EM debt are not likely to continue at the robust pace of the past few years now that yield spreads versus industrialized-country debt have narrowed. However, further modest tightening in EM spreads coupled with a higher average coupon versus DM sovereigns should lead to positive returns and outperformance in the months ahead. The current spread about 260 basis points is well above the record low of 127 basis points seen in early 2007 and comfortably above the tightest recent reading of about 240 basis points from December 2010 (Chart 4). We believe the rerating of EM sovereigns over the past several years is likely to continue and is consistent with the secular tighter-spread trend. After all, each of the four BRIC countries (Brazil, Russia, India and China) now carries an investment-grade rating. The relatively low current yields within the DM universe lead us to believe there is a heightened degree of vulnerability for sovereign debt among the G10 group of nations. This sets up EM debt for outperformance. Consequently, we are making a small adjustment to our tactical allocations that results in a larger underweight within the DM government/government-related sector and an overweight for EM debt. Chart 4: Conditions are ripe for EM bonds With economic growth continuing at more than twice the rate of the major developed countries, we believe the rerating of EM sovereigns over the past several years is likely to continue and is consistent with the secular tighter-spread trend. 1,000 Basis Points Citigroup Global Emerging Market Sovereign Bond Index Average Trend Source: Citigroup Global Markets, Inc., FactSet Research System as of March 31, morgan stanley smith barney april 14, 2011

6 Global Investment Committee Asset Allocation Models The Global Investment Committee (GIC) is made up of senior professionals from Morgan Stanley & Co. Incorporated Research, Morgan Stanley Smith Barney, Citi Investment Research & Analysis and outside financial market experts. The committee provides guidance on investment allocation decisions through the creation and maintenance of various model portfolios. The GIC s Asset Allocation Models shown on the following pages represent its best thinking on strategic and tactical asset allocation. In these portfolios, the strategic equity allocations are in proportion to their share of global market capitalization based on the MSCI All Country World Investable Market Index. As such, the strategic allocation to non-us stocks is more than 50% of the total equity allocation. There are three sets of models designed to provide guidance for investors with less than $1 million (Level 1), between $1 million and $20 million (Level 2) and more than $20 million in investable assets (Level 3). Accordingly, the portfolio sets have varying levels of allocations to traditional asset classes, liquid alternative investments and illiquid investments. The GIC constructs each set of portfolios on a scale of increasing risk that is, expected volatility and expected return. Each set consists of eight risk-tolerance levels. In each case, model 1 is the least risky and is composed mostly of bonds. As the model numbers increase, the models introduce higher allocations to equities and, thus, become riskier. Alternative/absolute return investments are present in all models and provide increased asset-class diversification. The GIC has also created and maintains strategic and tactical allocations for several other model portfolios used in various advisory programs. Most of these model portfolios incorporate a home-country bias toward the US. Under this subjective constraint, the strategic equity allocations have a 70%/30% split between US and non-us markets, and the strategic fixed income allocations have an 80%/20% split. 6 morgan stanley smith barney april 14, 2011

7 Global Investment Committee Asset Allocation Models for Investors With Less Than $1 Million in Investable Assets (Level 1) Tactical Changes Effective April 15, 2011 and Inflationlinked Securities, Global Equities and Alternative/Absolute Return Investments Global Equities and Alternative/Absolute Return Investments Model Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Global Cash 30% 28% 15% 13% 10% 8% 8% 6% 5% 3% 3% 1% Investment Grade Short Duration Government/ Government-Related Corporate & Securitized High Yield Emerging Markets Total Bonds Total Cash & Short Duration Bonds Global Equities US Large Growth Value US Mid Growth Value Canada Europe Europe ex UK UK Developed Asia Japan Asia Pacific ex Japan US Small Growth Value World ex US Small Emerging Markets Total Equity Total US Equity Total Developed ex US Equity Total Developed Market Equity Total Emerging Market Equity Global Alternative/Absolute Return Investments REITs Commodities Inflation-Linked Securities Managed Futures Hedge Funds Private Real Estate Private Equity Total Alternative/ Absolute Return Investments morgan stanley smith barney april 14, 2011

8 Global Investment Committee Asset Allocation Models for Investors With $1 Million to $20 Million in Investable Assets (Level 2) Tactical Changes Effective April 15, 2011 and Inflationlinked Securities, Global Equities and Alternative/Absolute Return Investments Global Equities and Alternative/Absolute Return Investments Model Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Global Cash 25% 23% 13% 11% 8% 6% 5% 3% 3% 1% 2% Investment Grade Short Duration Government/ Government-Related Corporate & Securitized High Yield Emerging Markets Total Bonds Total Cash & Short Duration Bonds Global Equities US Large Growth Value US Mid Growth Value Canada Europe Europe ex UK UK Developed Asia Japan Asia Pacific ex Japan US Small Growth Value World ex US Small Emerging Markets Total Equity Total US Equity Total Developed ex US Equity Total Developed Market Equity Total Emerging Market Equity Global Alternative/Absolute Return Investments REITs Commodities Inflation-Linked Securities Managed Futures Hedge Funds Private Real Estate Private Equity Total Alternative/ Absolute Return Investments morgan stanley smith barney april 14, 2011

9 Global Investment Committee Asset Allocation Models for Investors With $20 Million or More in Investable Assets (Level 3) Tactical Changes Effective April 15, 2011 and Inflationlinked Securities, Global Equities and Alternative/Absolute Return Investments Global Equities and Alternative/Absolute Return Investments Model Portfolios Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Strategic Tactical Global Cash 25% 23% 13% 11% 8% 6% 5% 3% 3% 1% 2% Investment Grade Short Duration Government/ Government-Related Corporate & Securitized High Yield Emerging Markets Total Bonds Total Cash & Short Duration Bonds Global Equities US Large Growth Value US Mid Growth Value Canada Europe Europe ex UK UK Developed Asia Japan Asia Pacific ex Japan US Small Growth Value World ex US Small Emerging Markets Total Equity Total US Equity Total Developed ex US Equity Total Developed Market Equity Total Emerging Market Equity Global Alternative/Absolute Return Investments REITs Commodities Inflation-Linked Securities Managed Futures Hedge Funds Private Real Estate Private Equity Total Alternative/ Absolute Return Investments morgan stanley smith barney april 14, 2011

10 Index Definitions standard & poor s 500 index Widely regarded as the best single gauge of the US equities market, this capitalizationweighted index includes a representative sample of 500 leading companies in leading industries of the US economy. msci all country world index This freefloat-adjusted marketcapitalization index is designed to measure equity market performance in the developed and emerging markets. russell 1000 growth index This index measures the performance of the Russell 1000 companies with higher priceto-book ratios and higher forecasted growth rates. russell 1000 value index This index measures the performance of the Russell 1000 companies with lower priceto-book ratios and lower forecasted growth rates. msci emerging markets index This is a free-float-adjusted market-capitalization index designed to measure equity market performance in the global emerging markets. msci world index This free-float-adjusted market-capitalization index measures performance of 24 developed equity markets. citi broad investment grade (big) bond index This index comprises US-dollar investmentgrade securities with minimum ratings of Baa3/ BBB-, minimum denominations of $250 million, minimum maturities of one year, minimum par amount of $1,000 and a fixed coupon. citi high yield market index This index captures the performance of below-investment-grade debt issued by corporations domiciled in the US or Canada, including cash-pay and deferredinterest securities. All the bonds are publicly placed, have a fixed coupon and are nonconvertible. Bonds issued under Rule 144A are included in their unregistered form. dow jones-ubs commodity index This index comprises futures contracts on 19 physical commodities. These include energy, industrial metals, precious metals and agricultural commodities. hfri fund-of-funds composite index This is an equal-weighted index of 650 hedge funds with at least $50 million in assets and 12-months of returns. Returns are reported in US dollars and are net of fees. hfri equity hedge index Equity hedge funds maintain long and short positions in equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques. Strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage, holding periods, concentrations of market capitalizations and valuation ranges. hfri equity market neutral index These strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. These can include both factorbased and statistical arbitrage/trading strategies. Factor-based investment strategies include strategies in which the investment thesis is predicated on the systematic analysis of common relationships between securities. In many but not all cases, portfolios are constructed to be neutral to one or multiple variables, such as broader equity markets in dollar or beta terms, and leverage is frequently employed to enhance the return profile of the positions identified. Statistical arbitrage/trading consist of strategies in which the investment thesis is predicated on exploiting pricing anomalies, which may occur as a function of expected mean reversion inherent in security prices; high-frequency techniques may be employed and trading strategies may also be employed on the basis of technical analysis or opportunistically to exploit new information the investment manager believes has not been fully, completely or accurately discounted into current security prices. Equity market neutral strategies typically maintain characteristic net equity market exposure no greater than 10% long or short. hfri event driven index Investment managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event-driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company-specific developments. Investment theses are typically predicated on fundamental characteristics, with the realization of the thesis predicated on a specific development exogenous to the existing capital structure. hfri macro index These funds trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of topdown and bottom-up theses, quantitative and fundamental approaches and long- and short-term holding periods. hfri multi strategy index This index measures the performance of mulitstrategy managers. They typically maintain positions in companies currently or prospectively involved in corporate transactions including mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. 10 morgan stanley smith barney april 14, 2011

11 Disclosures This material has been prepared for informational purposes only and is not an offer to buy or sell or a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This is not a research report and was not prepared by the Research Departments of Morgan Stanley & Co. Incorporated or Citigroup Global Markets Inc. The views and opinions contained in this material are those of the author(s) and may differ materially from the views and opinions of others at Morgan Stanley Smith Barney LLC or any of its affiliate companies. Past performance is not necessarily a guide to future performance. The author(s) (if any authors are noted) principally responsible for the preparation of this material receive compensation based upon various factors, including quality and accuracy of their work, firm revenues (including trading and capital markets revenues), client feedback and competitive factors. 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12 Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond s maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate. Bonds rated below investment grade may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk and price volatility in the secondary market. Investors should be careful to consider these risks alongside their individual circumstances, objectives and risk tolerance before investing in high-yield bonds. High yield bonds should comprise only a limited portion of a balanced portfolio. Treasury Inflation Protection Securities (TIPS) coupon payments and underlying principal are automatically increased to compensate for inflation by tracking the consumer price index (CPI). While the real rate of return is guaranteed, TIPS tend to offer a low return. Because the return of TIPS is linked to inflation, TIPS may significantly underperform versus conventional US Treasuries in times of low inflation. Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment. 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