UBS’ O’Neill on the potential risks awaiting investors next year
Banks could, however, help lift the economy in 2015. Demand for credit has turned from negative to positive in recent months. The completion of the ECB’s asset quality reviewshould make banks more confident in extending credit, especially given the very low cost of borrowing.
Yet, concerns are still abundant, with a ‘diverging world’ sitting right at the top of the risks that worries us the most. There are both good and bad divergences occurring, and we spend a lot of time thinking about its effect on investments.
One bad divergence is the geopolitical turmoil in several areas around the globe. Some of these risks remain extremely difficult to quantify and have kept many investors away from some long-term investments.
Even good divergences, and I would consider the self-sustaining growth developing in the US and UK to be of this kind, threw up some uncertainty because they raise questions about the nature of this cycle. We continue to sail deeper into uncharted waters with regards to monetary policy, and are not any closer to normalising in many parts of the world, which is creating unusual demands on asset allocations.
All of this will make investing in 2015 and beyond challenging but manageable, provided investors follow some key risk avoiding principles:
First, portfolio risk needs to be re-examined. As divergences make themselves felt sharply in individual asset classes and regions, it will be critical for investors to try and offset the risks of a diverging world by ensuring their portfolios are well diversified and are not overexposed to any individual asset, asset class, or region. At times, this will represent a cost to performance, but the commensurate reduction in risk and volatility will more than compensate.
Practically, portfolios will need to be hedged against potentially outsized currency moves, home biases should be monitored, and asset allocation must be examined for concentration risks.
Secondly, opportunities in short-term tactical investments will likely be more frequent in a diverging world. But so will the risks. On the upside, this should create greater potential for tactical positioning and investments to generate returns, and ample opportunities for alternative managers to create returns above benchmark.
Indeed, with overall financial market upside likely to be limited from here, it will be essential for investors to take up such opportunities.
However, investors need to ensure such positions are taken on in a risk-controlled manner. This is particularly important in an environment of rising volatility and potentially outsized market moves.
While divergence may be the foremost risk that worries us most; there are certainly others that investors should be conscious of as we enter into 2015, which include:
- Inequalities: the rise of the radical world
- Political uncertainty, given national polls across Europe in 2014
- The fragility of the global economy
- Chinese property market declines
- A re-escalation of the eurozone crisis
- Inflation with no growth