Some of the major investment themes that began last year are still unfolding. The collapse in oil prices, the depreciating euro and surging bond prices are among this group. But other opportunities will arise.
Which segments of the global equity market offer value? How can advisors hedge against volatile currency fluctuations? Where do alternative beta strategies fit in?
Dodd Kittsley, head of ETF strategy at Deutsche Asset & Wealth Management shared his thoughts with Research.
As you look at the months ahead in 2015, which investing trends do you think we’ll see playing out?
More dollars were invested in ETFs in 2014 than ever before. We expect this growth to continue and accelerate in the coming year, driven by increased investor adoption and product innovation. While indexing has been employed by institutional investors for nearly five decades, many advisors and individual investors are just becoming aware of the benefits that these strategies can deliver. Indexing delivers broad diversification to thousands of individual markets and exposures and allows investors to take advantage of broad macro trends in an efficient way.
ETFs offer a low cost, tax efficient and easily tradable way to build portfolios that are transparent, risk controlled and diversified. They also allow investors to capitalize, in a single trade, on compelling themes and strategies. In 2015, we expect to see continued demand for investors to control risk in their bond portfolios through duration management. We also believe that investments in stocks outside the US are particularly attractive, when controlled for a stronger US dollar. Currency hedged ETFs saw massive growth in 2014 and assets in those funds now exceed $20 billion. We believe this growth is just the beginning as investors now have the ability to invest internationally, in a variety of different markets and countries, while eliminating the impact of currency fluctuations.
The S&P 500 has recorded five consecutive yearly gains but a market correction is inevitable. What should advisors being doing right now to prepare their clients?
At Deutsche Asset & Wealth Management, we believe that corporate profits could see a new high in 2015, leading to further appreciation for the S&P 500 and other U.S. stocks further down the market cap spectrum. Due to the prolonged bull market, stock valuations have become rich and will likely react more strongly to economic and company data. Nevertheless, in our view, the environment for stocks remains positive overall in 2015. The low interest rate environment is causing capital inflows into stock markets. We expect a moderate acceleration in global economic growth and inflation to remain low. While the Fed will likely raise rates, we expect them to do this modestly in the third quarter of 2015 at the earliest. That means we will keep the Goldilocks scenario for the markets in 2015. Slow and steady global economic growth will likely translate into positive returns for most equity markets in the coming year.
How do currency fluctuations impact equity performance and under what circumstances does it make sense to hedge currency positions?
Currency exposure can have a massive impact on the total return of international equities, which was a lesson learned by many U.S. investors with Japan in 2013 and, more broadly, with most international markets in 2014. The dollar strengthened against most major currencies over the course of the year, detracting significantly from equity returns. Many international indices, including the MSCI EAFE Index, have delivered positive returns year-to-date in local currency terms, but are in negative territory for un-hedged US investors, because of the magnitude of their currency losses.
We believe that investors with a neutral to positive outlook for the dollar should consider hedging their currency exposure. Dollar bulls will want to fully hedge and eliminate the impact of currency entirely. Those without a currency view should also consider a currency neutral position and fully hedge their currency exposure. Another approach, for those uncertain of currency movements in the coming year, would be to hedge half of one’s currency exposure.
The forces that drove the dollar higher in 2014, namely economic and central bank divergence between the U.S. and developed international markets, are likely to persist in 2015 and beyond. We think currency hedging is absolutely essential for investors who intend to participate in developed international equity markets in the years to come. Within emerging markets, we have seen increased volatility in currency movements relative to the U.S. dollar, which is likely to persist in 2015. Currency hedging to reduce volatility in emerging market positions is a strategy that has recently been embraced by investors and we believe will be effective in the years to come.
What regions of the global equity market do you believe offer good value?