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Market risk has shot up since beginning of year, says Canaccord Genuity

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The Canaccord Genuity Wealth Management (CGWM) Market Stress Indicator (MSI), which measures market risk on a scale of one to five, has risen to four from 2.5 at the start of this year.

This increase which puts markets at stressed levels is due to the rising risk of an emerging market growth shock against a backdrop of central bank stimulus being withdrawn. Correlations between asset classes have spiked and volatility has edged up over the course of January and early February.
 
CGWM's Risk Enhanced Multi-Asset Portfolios (REMAP), a suite of seven risk-rated, multi-asset portfolios designed for financial advisers seeking to outsource fund selection and asset allocation, are underweight risk assets.  Throughout all market conditions, REMAP endeavours to maintain a steady level of risk in keeping with investors' risk tolerance.
 
Robert Jukes and Edward Smith, co-managers of the REMAP portfolios, are seeking investments to diversify away from equity market risk.  Recent trades include exposure to infrastructure via HICL Infrastructure and International Public Partnerships, and a currency pairs trade, going short the Canadian Dollar and long the US Dollar.  In January 2014, they reduced holdings in a real estate ETF as well as oil and took profits in Europe while they used recent bond market strength to reduce fixed income exposure.


 
Edward Smith, global strategist and co-lead manager of REMAP, says: “Both equity market volatility and the correlation between regional equity markets and other risk assets, such as commodities or property, have risen. Our mandate to cap risk means that we have needed to take some of it off the table. We have reduced holdings in a developed market property exchange traded fund (ETF) and another ETF that invests in oil. The former has been very sensitive to the outlook for monetary policy and we believe it will struggle this year as Quantitative Easing and central bank stimuli are withdrawn. The recent equity market falls have been driven by fears of economic instability in emerging markets and the risk of a policy misstep in China as it looks to cool its credit driven economy, and this will likely weigh on the price of oil. As the indicator moved to four, we moved money out of Europe, taking profits here after a stunning 2013. Our forecast is for anaemic growth in the region, while German exporters will be blighted by emerging market woes, and investors will no longer be rewarded for the additional portfolio risk.
 
“The challenge for asset allocators in 2014 is to identify investments that have a low correlation with both bonds and equities – investments that will diversify portfolio risk in all market conditions while also providing a return. To that end we used the recent strength in the bond market to reduce our holdings in high quality fixed income, and we reinvested the proceeds into what one might term ‘alternative diversifiers’.
 
“We have purchased the Ignis Absolute Return Government Bond fund – employing a strategy that trades interest rate differentials between government yield curves while stripping out the general direction of bond market movements – and an ETF that holds a long position in the US dollar relative to the Canadian dollar. We expect our clients to benefit as the American Dollar strengthens compared to the Canadian Dollar. As profitable investment opportunities in commodities have dried up, we believe money will start flowing out of Canada and back into the US, where economic growth will come closer to the pre-crisis average than in any other developed market economy. The Canadian private sector is dangerously over-indebted and our fair value model suggests the USD could appreciate by >10 per cent against the CAD.”

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