Stephane Deo, global head-asset allocation, UBS Investment Bank explains to CNBC-TV18 that the fiscal imbalances in India are a cause for worry for overseas investors. Deo advises investors that the QE rally could be played by betting on copper especially in China from the end of this year or the start of next year.
Below is an edited transcript of the analysis on CNBC-TV18.
Q: A couple of days ago you pointed out that flows into emerging markets (EM) are not as strong perhaps as they were in QE1 and QE2 and if they don't pick up, you would have to review your strategy. Do you continue to hold that view? What are your thoughts on asset allocation?
A: The note you mention looks at the flow of funds into EM because on our asset allocation for the time-being, we have overweighed equity on the back of the speech by Draghi, but also on the back of QE and we are essentially overweight on emerging markets as our research has shown that during QE1 and QE2, the major beneficiary was EM equity.
But with no flow of funds into EM equity, it looks like QE3 is less efficient in terms of boosting EM equity than QE1 and QE2.
Q: You pointed that the EM asset allocation strategy you were has not been as effective this time around. What do you think is the trigger that many fund managers would be waiting for to make further allocation to emerging market equities?
A: I think the growth rate is probably the key trigger. What we have seen recently is the GDP in emerging market has over-performed the GDP in developed markets, which has been the case for the past 15 years. But the levels of profit have not over-performed in EM. I think there more growth is needed to trigger increased flows into EM.
Q: How do you see asset allocation for the remaining part of 2012? If you think that QE3 has been juiced out, what would be perhaps the top three asset performers?
A: We do not think QE3 has been juiced out. The reaction, which was quite sharp at the beginning of September when it was announced, has been more muted. But as the Fed continues to proceed and put money in the system, I think it will have some effect.
Though the effect which began to be less important than we were expecting, we are still risk-on. On our portfolio, we are long on commodities on QE and we are long on equities as well, again with an empahsis on emerging markets.
So, that's still very much the case right now and to be honest, EM equities are starting to over perform again, very marginally, but they are starting to. So I suggest investors keep their positions for the time being.
Q: How do you feel about India? India has had some outperformance driven by reform measures announced by the government. Do you think if the RBI does cut rates there could be additional allocation towards India?
A: It's possible, but these kinds of arguments are very short-term. Though the central bank can provide some support for the economy, what worries me about India are the imbalances; the external imbalances and the deficit which are not only important but also growing to some extent. I think there are structural issues which have me worried about India.
Q: You spoke about equities and commodities as being your preference given that you are still on risk-on mode. How would crude pan out? We saw it capped at USD 112 per bbl and suddenly the Turkey-Syria tension has brought it up to USD 116 per bbl? Will mellow growth once again bring it back and would your average for crude be lower than what it is at present?
A: When I was thinking about commodities I should have been more specific on metals and precious metals. In terms of energy, we still have a supply which is high and the growth rate of the economy is not very big. So in that we still expect the energy price to remain where it is. We do not think oil prices will increase a lot.
So, the way to play this rally, if you believe that it's a QE rally, is to bet on copper. We are very bearish on copper on the long-term and we think you will benefit from restocking probably in China at the end of the year and beginning of next year. So I am thinking much more in terms of industrial metals rather than energy products.