UBS shares 6 ways investors can adjust their portfolios for the second quarter as we head into an environment filled with volatility, uncertainty and rising inflation

  • Markets dealt with clashing forces that created volatility last quarter. 
  • While volatility is likely to persist in the near term, UBS remains positive on risk assets.
  • The bank details six ways in which investors can adjust their portfolios accordingly. 
  • See more stories on Insider’s business page.

The first quarter of this year turned out to be an interesting period for the markets. 

In January, individual stocks like Gamestop experienced high levels of volatility due to short squeezes that were driven by retail traders. The following month, the 10-year yield rose above 1.3% for the first time in nearly a year as inflation expectations rose. The COVID-19 vaccine rollout accelerated and value has outperformed growth over the past month as the economy advances through the recovery cycle and continues to reopen. 

Now, as we head into the second quarter, investors will continue to face volatility, but the good news is that the macroeconomic environment today is favorable for risk assets, according to Mark Haefele, the chief investment officer of UBS Wealth Management. 

As economic restrictions continue relaxing and more people get vaccinated, corporate earnings and GDP are set to recover. That’s because consumers are looking to spend their savings and return to activities that COVID halted. As such, he expects GDP growth in the US to accelerate and reach about 6.6% by year-end.

However, inflation may pick up because of further efforts to reopen the economy alongside policy support and supply-demand imbalances. The pick-up in consumer demand that’s met with ongoing supply constraints could also cause rising prices in some industries, he said.  

Against this backdrop, Haefele detailed six ways in which investors can adjust their portfolios accordingly. 

6 portfolio adjustments

The first way is to position for reflation, which refers to a recovery phase in which both growth and infla­tion are accelerating. 

“In our base case, we think the rotation into value and cyclicals will continue in the near term, supported by the broadening recovery and faster growth,” he said.

And in this type of environment, he favors reflation beneficiaries such as the financials and energy sectors. Both look attractive to him, tend to do well when rates rise, and have catch-up potential as they have underperformed the S&P 500 since the end of 2019. 

Investors looking to position for reflation by gaining exposure to financials and energy might want to consider ETFs like the Vanguard Financials ETF (VFH) and the Fidelity MSCI Energy ETF (FENY), respectively. 

Haefele also sees potential for ongoing outperformance for small-caps over large-caps given their “historically” attractive valuations and cyclical exposure, he said. 

For those looking to gain exposure to small-caps, the Schwab U.S. Small-Cap ETF (SCHA) is an example of an exchange-traded fund that seeks to track the total return of the Dow Jones U.S. Small-Cap Total Stock Market Index before fees and expenses. 

UBS’ second recommendation is to hunt for the yield, given that across most scenarios, they expect interest rates to remain below the inflation rate even as bond yields continue to rise, he added. 

That being said, long-term investors will need to replace negative real-yielding assets, or assets that cost more than what they pay in income, like cash, with ones with positive real yields including dividend stocks or parts of the credit spectrum. 

Haefele and his team prefer US high yield bonds as well as US senior loans.

“The strong economic recovery we expect in the US should limit defaults, and as a result of a 10% default rate in 2020 and fallen angels entering the segment, average credit quality in HY has improved,” he said. 

The third consists of using volatility to invest and protect. 

“A higher-volatility, lower-correlation environment should also provide fertile ground for select hedge fund strategies to outperform,” he said. 

And with the pandemic having accelerated structural change, he recommends positioning for structural growth. 

There may be near-term volatility and uncertainty in growth stocks, but that shouldn’t affect their long-term earnings growth potential, he said. 

Consequently, investors can use pullbacks to build longer term positions in tech themes including 5G, fintech, greentech, and healthtech, according to Haefele. 

An example of an ETF that invests in companies that are engaged in the theme of financial technology innovation includes the Ark Fintech Innovation ETF. 

The fifth way includes seeking opportunities in Asia. 

“Strategically, we think allocations to Asia and China are crucial for long-term portfolio returns and diversification,” he wrote.

Asia holds some of the most compelling growth opportunities in the coming years. China’s intelligent infrastructure segment, for example, houses companies that they expect will see double the rate of earnings growth of the overall market in 2020 to 2021, he added.  

Within the region, they favor equity markets in China, India, and Singapore. China, however, is already the world’s largest e-commerce market and can become the first large economy to introduce a digital currency. As such, they are positive on China’s leading internet platforms, select banks and global fintech leaders, according to Haefele. 

In this respect, the iShares MSCI China ETF offers exposure to large and mid-sized companies in China; and the Franklin FTSE India ETF seeks to provide investment results that closely match an index of Indian large and mid-cap stocks.

And the final way involves going sustainable. 

Sustainable investing strategies incorporate environmental, social and governance (ESG) factors into investment process and portfolio construction, and UBS expect parts of the sustainable investing universe to experience rapid revenue and profit growth in years ahead, he said. 

“Greentech is one of the highest-profile components of sustainable investing and among our preferred long-term investment themes,” he added. 

That being said, the Invesco WilderHill Clean Energy ETF generally invests at least 90% of its total assets in companies that advance cleaner energy and conservation.

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