Investment Insight, 01/10/2021
Highlighted in James’s piece this week, the yield on UK Gilts and US Treasuries has risen in the second half of September. As seen during the first half of the year, when the rise in yields was even more pronounced, these moves have affected short term portfolio performance with our fund strategies impacted to varying degrees, which will be analysed below.
As communicated post our most recent Investment committee meeting (6th August), and in keeping with TS Lombard’s central macroeconomic view at the time, we believed that yields were too low, after rising too sharply earlier in the year, with fair value somewhere in the middle of these two points. Committee discussions were therefore focused on adjusting portfolios to protect against rising yields with the following action points approved and subsequently implemented:
- Shortened duration of fixed income portfolio with additions of Artemis Target Return Bond Fund and Vontobel Global Emerging Markets Corporate at the expense of longer duration Credit
- Portfolios rebalanced with the net effect of reducing Equity exposure and bringing individual funds back to target weights
Although an exceptionally short period, these changes have proved accretive thus far, especially in our lower risk portfolios where fixed income is a larger overall allocation. We actually touched upon these changes in an article published in last month’s edition of Citywire: MPS Investment Committee: Nick Gait, Tideway Wealth – Citywire.
As highlighted many times previously, we take a balanced approach to our Equity allocation holding a core of Global strategies allocating to all the major investment styles, Value, Growth and Quality. We do not believe we can consistently time style or sector rotations as it is often too late to implement once a catalyst appears and the market moves. We believe this balance gives us the ability for both competitive and smoother returns over a long-term time horizon. From time to time, we will however look to tilt allocations towards a specific style should we think the macroeconomic environment warrants.
As can be seen in the table below Value funds have performed well over the last week with rising yields beneficial for popular value sectors such as Financials, Industrials and Energy. Conversely growth funds have performed poorly as they typically allocate capital to longer duration investments which project a greater proportion of their cashflows into the future. Discounting these cashflows, which are often many years in the future, back at higher rates leads to a lower current valuation. This has been a small reversal to the trend we have seen over the last quarter.
Although simplified analysis of the above these strategies (discounting stock selection completely over this period) these trends are consistent with what we saw earlier in the year when yields were on the rise. It must be noted however that performance has also been masked slightly with dollar strengthening over the period with assets falling more in local currency terms.
As with our Equity allocation, our approach to fixed income is well documented, believing that investing in government bonds (traditionally considered a safe haven) to be a source of return free risk, especially at longer maturities. In lieu of government bonds we allocate to a range of credit strategies which we believe will provide better returns of the long term, accepting higher volatility in times of market stress. As referenced in our Citywire article, we have attempted to maintain a shorter duration positions, to avoid larger losses when yields rise. Clients have benefited from an allocation to Target Return Bond, positive over the period, and a reduction in longer duration Credit which has been the worst performer over the period. Overall returns appear favourable versus our IA Strategic Bond benchmark.
Taking a longer-term view, rising yields is actually a positive for these strategies over the longer term allowing cash flows to be reinvested at higher rates, and managers to take longer duration positions once the yield curve has steepened.
We are currently happy with our allocation to alternatives believing that we have good protection from inflation and rising yields. On 1st April this, we wrote a more detailed piece on this topic ‘Inflation Protecting Portfolios’ and how it pertained to Schroder Global Cities and Franklin Templeton Global Infrastructure (formerly Legg Mason).
Sanlam Multi-Strategy allocates to three distinct strategies: Fixed Income, Real Assets and Equity. Allocations to Fixed Income are short duration in nature, Real Assets are generally a good inflation hedge, whilst the fund also utilises option strategies which help reduce the effect of falls within the equity market.
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