The global economy appears to have entered a new phase — one of synchronized sustainability — but markets have been rising, and much of the good news is reflected in asset prices, particularly in the U.S. These conditions raise a number of questions heading into 2018: Where are we in the economic cycle? Is the U.S. priced for perfection? Have investors missed the rally in European equities? Will rising inflation impact asset prices? Here are key investment themes to consider and guidance on positioning portfolios for 2018:
Equity portfolios at Capital Group are constructed through individual security selection based on fundamental, bottom-up global research, rather than top-down tactical shifts. Through this bottom-up process, a number of themes have emerged. The table below shows shifts in regional equity weightings over the past six months across American Funds equity-focused portfolios. The shifts represent any allocations of 1% or greater during the period. Emerging markets exposure has been added across strategies, while European exposure has generally been increased and the reverse has been true with regard to U.S. exposure.
At this stage of the cycle, ensure portfolios are well diversified, with the flexibility to pivot to select areas of opportunity.
Maintain a core allocation to U.S. equities but consider rebalancing toward international and emerging market equities.
Seek meaningful exposure to Europe’s improving health and rising consumer purchasing power in emerging markets.
The asset allocations below are drawn from the 13 American Funds model portfolios, which are established by Capital Group’s Portfolio Oversight Committee. The committee, a team of experienced portfolio managers, makes strategic allocations to underlying American Funds based on stated investment objectives. The themes that follow are reflected in the asset allocations:
Maintain a core allocation of U.S. equities but market levels call for selectivity and rebalancing toward international and emerging market equities.
Seek meaningful exposure to international and emerging market equities for the potential to gain from Europe’s improving health and rising consumer purchasing power in emerging markets.
Seek to construct core bond portfolios that are positioned for rising volatility, with limited exposure to lower quality credit or high yield, which can provide relative stability and diversification.
How might the insights within this 2018 Outlook be reflected in the fixed income allocation of an investment portfolio? Considering a portfolio that contains 60% equities and 40% fixed income, here is how one might construct a fixed income allocation using funds from American Funds.
To seek diversification for your broader portfolio from equities, consider a 20% weighting using The Bond Fund of America at its core. Tax-aware investors might want to consider The Tax-Exempt Bond Fund of America as an alternative. For a measure of capital preservation, consider a 5% weighting to the Intermediate Bond Fund of America, which yields somewhere between 2% and 2.5% for a three-year duration. Tax-aware investors might consider Limited Term Tax-Exempt Bond Fund of America.
To seek a measure of enhanced income, consider a 10% allocation to American Funds Emerging Markets Bond Fund. Tax-aware investors might opt to invest in American High-Income Municipal Bond Fund. Finally, consider a 5% allocation to American Funds Inflation Linked Bond Fund to seek a measure of inflation protection. The portfolio had a yield of 3.4%, 5.5 years of duration and zero correlation to the equity market for the three-year period ended December 31, 2017.
For tax-aware investors at the highest tax bracket, swapping out the funds for tax-exempt counterparts results in a portfolio that had a tax-equivalent yield of 5.2% with 6 years of duration and correlation to equities of —0.2 for the three years ended December 31, 2017.