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ANALYSIS

Frozen by the entanglement of risk

Equity prices in continental Europe and emerging markets, including China, are below fair value, and present an opportunity for investors, but the ‘entanglement of risk’ in current markets is making Brian Singer, partner and head of dynamical allocation strategies team, William Blair cautious.

William Blair typically targets around 10 per cent volatility in its portfolios, but at the moment it is taking below average risk, with volatility around 6 per cent.

“We are very cautious right now,” Singer said.

“The entanglement of risk – commodity prices, China growth, Europe, and Fed policy – leads us to be more cautious than would otherwise be the case,” he says.

The two areas in global equities that he does see opportunity are continental Europe and emerging markets.

Over the long term William Blair thinks that China’s growth will be around 5 to 7 per cent.

“China’s growth is slowing and the world collapsed. That is not a sustainable approach.”

“In the short term if the market is focusing its attention on a 3.5 per cent reduction in China’s currency then we think that is an opportunity.”

However while the prices are below fair value, and present an opportunity, there is too much uncertainty and opaqueness.

“Fundamental value is a long-term concept. It is important to know what the economy is doing over the long term, but in the short term you can take advantage of the market’s mis-perception.”

Singer says that increasing geo-political instability and the interconnectedness of risk means investors need a deductive framework to deal with information.

“Most investors think indeductively, they see patterns from history. So how do we get context in a world that’s complex and inter-related,” he says. “There is a diminishing marginal return to information, as you get more information your confident increases even though the information is not more useful.”

Instead he advocates for an inter-related framework to assessing investment opportunities which looks at fundamental value, which is not driven by history; market behaviour analysis, in order to understand why prices deviate, this explained by game theory; and risk capital allocation.

“We identify macro themes, and create propositions that are affecting prices. These might include the commodity super-cycle, China’s growth or populism,” he says. “I defy you to understand Donald Trump, but he is a rejection of the established elite. People don’t believe what the established elite is saying, it doesn’t mean they believe Trump though.”

Populism was a theme that played out in Europe, with Singer saying that populism was the biggest threat to the Eurozone and stopping it has been one of Germany’s motivations.

“Most of the risk is behind us and we are buying. We increased risk in all places where there was populist dissent including Spain, France, and Italy.”

Singer says William Blair does not try and forecast the economy or monetary policy, but tries to understand what the market thinks.

“Is it operating from fear or greed? If can understand that, then we can understand why prices are deviating from fundamental values.”

“When we position a portfolio our job is to take risk, but the key to take compensated risk. If you don’t understand it even if it is compensated, then it is best left alone.”

 

Brian Singer will give a keynote at The Fiduciary Investors Symposium, Chicago Booth School of Business, October 18-20

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