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Defensive equity the appropriate de-risking strategy

Nick Langley, RARE

Infrastructure has been an unloved asset class over the past couple of years but fund manager Nick Langley believes a return to defensive assets in the year ahead will be good news for utility companies and other infrastructure assets.

Langley is co-chief executive and co-chief investment officer at RARE Infrastructure. At the end of a year when volatility returned to global equity markets, Langley believes “we are seeing a regime change which is likely to continue to play out in 2019.”

Langley says: “We don’t see the trade war ending any time soon. The trade war is impacting on global economic growth and at some point this will impact on S&P 500 earnings. It would seem to us this is a recipe for continued volatility in the year to come.

“But the fact remains that the US economy does have a decent head of steam. There is also a fair chance that Trump and the Democrats agree on an infrastructure centred fiscal stimulus.

“It would be premature to reduce equity exposure too drastically at this point. Instead, we think increased defensive equity exposure is in order, and infrastructure stocks are one of the key ways investors can achieve this.”

Over the three months to the end of November, Australian equities fell 9.3 per cent, international equities fell 6.6 per cent and emerging markets fell 6.3 per cent. The S&P Global Infrastructure Index (hedged AUD) was down 2.4 per cent over the three months and actually rose 1.6 per cent in November.

Langley says RARE’s view is that US economic indicators are at or near a peak and a US yield curve inversion (an indicator of recession) is approaching. Global growth has become de-synchronised, particularly in emerging markets, which are dealing with capital outflows and a stronger US dollar.

RARE also believes that the US sharemarket is vulnerable. “Valuations on any sort of long-term valuation metric, such as cyclically adjusted price to earnings, look toppy. The only other points in history where the S&P 500 CAPE was higher was on the eve of the 1929 crash and at the height of the dotcom bubble in 1999/2000.”

Most institutional investors are underweight infrastructure. A shift to more defensive assets could see the allocation to infrastructure in balanced portfolios rise from 5 per cent to 10 or even 15 per cent.

Langley says about 14 per cent of its portfolio is in US utilities. “US utilities are about one-third of our universe. At the moment we are underweight. Our view is that the utility headwind is dissipating and we are looking to increase our exposure next year.”