Investors still cowering in fear from their 2008 losses might have missed the stock market rally in 2013. Many chose to sit on the sidelines, and others are worried about a looming stock market bubble.
Cash holdings on the UBS Investor Watch Survey were at 22%. And globally, UBS clients hold 30% of their assets in cash or cash equivalents.
But this isn't the best idea because interest payments on cash deposits don't exceed the prevailing inflation rate.
So what should an investor do?
For those worried about a stock market bubble UBS' Andrea Fisher writes that "there is virtually no evidence that stocks have disconnected from fundamentals." She argues that until pretty recently, the S&P 500 was actually lagging the recovery in earnings. While she is "optimistic [on] the upward march in US equities" she thinks investors need to prepare for more volatility. Some of the best opportunities lie in sectors tied to U.S. economic growth.
Investors need to prepare for "several years of unusually low bond returns," Brian Nick, a senior portfolio strategist at UBS argues. Investors can lower bond risk by doing one of three things. 1. Lower the duration of the bond portfolio 2. Hold lower quality bonds 3. Try hedge fund strategies because they "traditionally exhibit low or even negative correlation to bond prices."
"Most hedge fund strategies cannot match bonds’ income or downside protection," Nick writes. "But we believe they will generate better returns over the foreseeable future while adding little to portfolio volatility. This makes them a valuable complement to bond portfolios."
Investors with large gold holdings (2-3% of their portfolio) should reduce their exposure in 2014, writes UBS' Andrea Fisher.
"Gold tends to do well when real interest rates are either falling or negative as well as when panic pervades the market. Over the past year, real interest rates have begun to increase. This development, along with softer demand from emerging markets, lower central bank purchases, and Fed policy tightening dialogue, help explain the sharp 21% year-over-year drop in global gold demand in 3Q13. Diminished investor appetite for gold in 2014 could result in an additional 300-500 tons (i.e. 7%-11% of yearly demand) of out- flows hitting the market. To balance supply and demand, gold could fall further to its marginal production cost of USD 1,050/oz-1,150/oz; an additional 12% loss from current levels."
To get more from your portfolio this year, UBS' Michael Crook, head of portfolio and planning research, thinks investors should consider doing three things, that emerge from 2013 Nobel Prize winning research of Robert Shiller and Eugene Fama.
1. Change your liquidity preference (buy illiquid securities). These illiquid assets also help investors avoid market timing risk.
2. Change your time horizon.
3. Invest with managers that have an edge through better market knowledge.
Nick also suggests that investors reconsider active management as the trend of portfolio managers being bested by the S&P 500 is beginning to reverse. "Regardless of the environment, we believe virtually all investors should invest using a balanced approach between active and passive management," writes Nick. "We find that higher-tracking error managers have greater potential to add value to portfolios, which makes them particularly useful for ful- filling asset classes on which we are neutral or underweight."
2014 is likely to be a challenging year for investors with higher stock market valuations and bond yields that are still low, but UBS thinks these strategies should help.
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