As signs of a soft landing strengthen, are these investors bullish or bearish?

In the first part of this multi-asset series, we looked at what the investment teams at GMO, Morgan Stanley Wealth Management, and MLC Asset Management think about markets currently and how they select assets.

Macro

How these investors are positioned across stocks, bonds and cash

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Below, we gather their views on global equities, which range from a focus on quality growth, with increasing confidence in equities at Morgan Stanley Wealth Management, to MLC’s neutral exposure and a preference for mid-cap Australian equities.

GMO’s equities position is something different, with a 50% allocation and a less orthodox way of harnessing the growth potential presented by the Magnificent Seven growth stocks.

We also find out how they’re positioned in the Alternatives space and they each name a part of the market that holds exciting potential but that many investors have overlooked.

Are you bullish or bearish on equities currently?

Alexandre Ventelon, head of research and investment strategy, Morgan Stanley Wealth Management, says the team has been rebuilding its equity allocation, “as we've seen the signs of a soft landing really piling up in the last six months”.

“We still have the view, with recession risk looming in the background, that we are late cycle. But with the soft lending narrative really coming through in the data, we have readjusted,” he says.

From its prior position of being underweight equities, the team is now neutrally allocated and has been selectively adding exposure.

“But the outlook for the next 12 months remains quite constructive, we see the economy recovering in the second half of the year and most likely the major central banks like the ECB and the Fed starting to cut interest rates in June,” Ventelon says.

With both growth and inflation decelerating, he notes this is usually a challenging time for corporate earnings.

“There’s only a small portion of the market that’s going to do well, and it’s those that benefit from secular drivers. Companies that are too cyclical, to consumer-driven, will continue to struggle if they don’t have the pricing power or strong franchises,” Ventelon says.

All up, this means a focus on Quality within the equities book, with Ventelon citing software firms, especially those in the AI space, and healthcare companies as appealing.

“These are the key thematics you want to be exposed to. You can capture a lot of that by investing in what we call the Quality factor, with a fund manager or ETFs,” he says.

Why GMO’s equity portfolio is a bit “weird”

That’s a term Ben Inker, GMO's co-head of asset allocation, uses to describe his team’s global equities exposure currently, referring to its low allocation to the US.

“We don't have much of the portfolio in US equities, with much more in Europe and Japan and a fair bit in emerging, although not much of that segment is invested in China,” Inker says.

Why is that?

“The US equity market has beaten the pants off the world over the last decade, and as a result, is trading at just about the biggest premium we’ve ever seen, in valuation terms,” Inker says.

His team sees several US names that are appealing but prefers to buy comparable companies in other markets. In such instances, these non-US names can trade between 20% and 40% lower than the US-based competitors.

That’s why about half GMO’s equity holdings are now in Europe and Japan, with only around 15% invested in US names.

Value stocks present a historic opportunity

“The spread between the valuations of value stocks and growth stocks are some of the widest we have ever seen in history,” Inker says.

“The nice thing about these companies is when you are trading [at these discounts], you don't need really good things to happen to get a good return out of companies. You just need catastrophically bad things to fail to happen and you'll get a pretty good return.”

Why MLC holds a neutral position on stocks

“From a macro, top-down perspective, our central case has inflation under control but is likely to take longer than the market expects it will to fall back into central banks’ comfort zone,” says MLC Asset Management's Dan Farmer.

Though he believes a recession can still be avoided, Farmer also regards some equities sectors as over-priced given the current scenario.

“We also envisage alternate scenarios where equities could surprise to the upside, which is why we think a neutral positioning is appropriate,” he says.

Within ASX mid-caps is where the team is most focused within its equity allocation, given the challenges they see ahead for active managers taking a broader focus on equities.

“We are building on our exposures to midcap Australian equities where we believe specialist active managers can add alpha and breadth to an Australian index that is so heavily exposed to banks and resources,” Farmer says.

“Likewise, emerging market valuations look attractive, albeit with risk around China deflation tempering our short-term outlook.”

How are you positioned within Alternatives?

Alternatives are a large area of focus for Morgan Stanley, which Ventelon describes as the “winner” of its most recent strategic asset allocation round. Traditionally, the space was regarded as a source of risk-adjusted returns, but the return prospects in his team’s seven-year outlook mean Alternatives now rival long-only asset classes such as equities.

In this environment of dislocation, Ventelon notes that hedge funds tend to do quite well, which is one part of the Alternatives space his team likes currently.

Private credit is the team’s preferred alternative asset class, seeing yields of up to 9% from some high-quality companies. “If you can withstand the related illiquidity, the potential for high single-digit returns for the next couple of years is very attractive,” Ventelon says.

Another way to back the “Magnificent Seven”

Outside of stocks, one-quarter of GMO’s portfolio is held in alternatives, which is quite high in relative terms.

“We can do that today because cash rates are high and if you are invested in these liquid alternatives, your underlying return is a cash return. That cash return is giving you four or five points more today than it was a few years ago,” Inker says.

Even though both bonds and equities look better than they did a couple of years ago, so do Alternatives, he explains. Within this segment, the biggest allocation is in a strategy that Inker’s team refers to as “equity dislocation.”

“This is explicitly long value stocks and short growth stocks around the world. We think it has a double-digit expected return because of how extraordinarily cheap value stocks are,” Inker says.

Having this long-short approach enables GMO to be even more diversified than a long-only approach allows. It also ties into another opportunity to benefit from what’s happening among the so-called “Magnificent Seven” companies.

Inker notes that owning Value stocks versus is implicitly a “giant bet against these companies, which are a big piece of the benchmark.”

“Here's a way I can try to express the fact that value looks cheap relative to growth, without having a giant bet on a handful of companies. I can have a much more diversified portfolio, both long and short.”

Why private credit appeals to MLC

In Alternatives, Farmer describes MLC Asset Management’s exposure as “mildly overweight.” It sees some of the best opportunities within “speciality finance, including litigation financing, niche asset-backed capital solutions, and opportunistic special situations.”

Private credit appeals because traditional financiers are pulling back, partly because of tighter capital restrictions.

“We are seeing particularly attractive returns in niche credit strategies, supported by underlying fundamental drivers quite different to those supporting assets in our broader portfolios,” Farmer says.

MLC typically invests in such assets using specialist external managers but is increasingly participating via co-investments in speciality finance deals.

What is one area of the market where you see strong opportunities that many investors are overlooking?

For GMO, it’s Japanese small-caps, particularly value-oriented stocks.

“That hasn't been fully participated in as foreign investors have warmed up to the idea of investing in Japan. They're still investing in the names they know. But some of the most compelling investment opportunities are in smaller-cap Japanese companies,” says Inker.

Such companies often enjoy strong market positions and in many cases are “quasi-monopolists” within their areas of specialty.

“The thing that has held them back for a long time is that they didn’t behave in a very shareholder-friendly way,” Inker says.

For many Japanese companies, their long-term focus on paying down debt, instead of investing for growth, has also held them back over the last 30-plus years, Inker explains.

“The good news is…the median Japanese small cap company has no net debt on their balance sheet, so there's nothing much left for them to buy back and they're starting to wake up to shareholder value,” he says.

“It's an area we are still quite excited about and even though Japan has done quite well, the small-cap value stocks haven't kept up fully and we think there's a lot of runway for them to continue to make money in the years ahead.”

India primed for growth

For Ventolon, India is his pick of under-appreciated investor opportunities.

“It's going to be the third-largest economy by 2027. And it's clearly overlooked by the market, probably due to some of the political volatility in the country,” he says.

Ventolon notes India’s supply-side sector is already well-developed but sees more happening within the industrial sector.

“As a result of what we call the multipolar world, we expect to see a lot of manufacturing activity going into India in the decade to come,” he says.

An uncorrelated sub-sector

Finally, MLC Asset Management’s pick is within a niche of the insurance market: natural catastrophe reinsurance. An area in which the team has successfully invested for 16 years, it currently offers mid-teen prospective returns in 2024.

“We think it is an attractive risk premium for something that’s essentially uncorrelated to everything else in portfolios,” Farmer says.

In case you missed it

Make sure you catch the first part of this two-part series, where the multi-asset investing experts from GMO, Morgan Stanley Wealth Management and MLC Asset Management explained how they build portfolios and their current macro views.