James Baxter, Managing Partner
There are a few investment market indicators we have in our sights to keep an eye on the big picture.
Treasury rates and inflation
US and UK gilt yields have stalled in April having reached lows of just over 0.5% last Summer. The US 10-year rate has settled at around 1.6%, just below the rate it was at the end of 2019 and well below the 3% it hit in late 2018 when its rise cooled equity markets. We need to keep an eye on inflation but we do not think there is currently cause for concern. Last recorded in March in the UK it was just 0.4%, forecasts for the next 12 months are 1.5%; still below the 2% target set by central banks.
Corporate bond yields
The yields on our short-dated bond funds, our lowest risk funds, are just under 3% and covering historic inflation plus costs. Our higher yield, longer dated funds are generating yields of around 4%, giving us inflation plus 1%, remembering the managers will generally add to these returns through active management. The short-dated funds are a good buffer against future withdrawal needs and lower the risk of portfolios. The longer dated higher yield funds should provide a pretty reliable return on a medium-term basis and in doing so help us meet our target returns with more consistency than if we just relied on equities.
The FTSE 100 passed 7,000 this morning. It is the fourth time we have been here, with the index first hitting this level at the end of 1999 twenty-one years ago. It did not hold that value for long, set back by the post millennium dot com crash. It regained it again in the Summer of 2007 only to be knocked off course by the Great Financial Crisis of 2008. It recovered it again by 2017 and stayed at or above that level till the end of 2019. I remember thinking in the Autumn that year it might finally push on and break free, 8,000 here we come. We all know what happened next. At the same time it is interesting to note that the more domestically focused FTSE 250 continues to achieve record highs, having risen by c.26% in the last six-month period.
US equities are pushing new highs but by contrast the S&P 500 is up almost threefold since the end of 1999. So, are US equities ridiculously expensive and UK equities ridiculously cheap?
On a forward basis, the S&P 500 earnings yield is c.4.5%, three times the US ten-year risk- free rate. The FTSE 100 companies, on a similar basis yield almost 7%. That these rates are not miles apart by now, after the relative movements of the two indices over the last 20 years, tells us that US companies have lived up to their historically higher valuations and have grown their earnings far more quickly than the FTSE 100 companies.
As we have discussed in this column before, the S&P 500 can be seen as a proxy for ‘growth’ companies; technology, health care and internet-based businesses, whilst the FTSE 100 is more of a proxy for ‘value’ or ‘cyclical’ style companies with earnings growth more routed to economic growth cycle; banks, insurance companies and energy companies. That the shares in these companies are gaining momentum reflects economic growth expectations and their relatively low values compared to other companies.
Today, China, the second largest economy on the planet, and almost five times the size of the UK economy, announced the biggest annual growth in economic activity since its records began at 18%. Whilst global economic growth may be muted, it is clearly not over and China is leading the way out of the pandemic.
It would be a brave person who bets against the US markets for the next 20 years, but in the short term our value funds have had a nice boost and we see more to come as economic activity picks up.
To follow, Nick Gait looks at where we are currently exposed globally and by sector in the equity funds that make up our portfolios as well as some of our top underlying holdings in both bonds and equities.
Nick Gait, Investment Director
In addition to regular meetings with our fund managers, Tideway closely monitors your portfolios daily using both internal and risk analysis provided by third parties. Our internal system is built around portfolio holdings provided by each of our managers periodically which is then used to form an aggregate view of client portfolios. It allows a full analysis of our exposures including commonalty of holdings and net geographical and sector exposures amongst other things. This is a valuable tool both to manage risk as well as helping to inform decisions when we look to open a position with a new manager or reduce exposure at Investment Committee meetings. Ultimately it will be the underlying companies that drive performance and therefore we believe it is vital to understand our overall positioning in detail.
It should be noted however that we are limited in what we can publish due to the agreements with the fund managers and therefore will not disclose the names of the securities or the managers who hold these securities unless they have been made available publicly on manager literature, such as factsheets.
Top Bond Holdings (Stable Return Three Model):
Top Equity Holdings (Equity Blend / Stable Return Models):
Taiwan Semiconductor (TSMC)
IShares MSCI World
From a geographical perspective we construct our portfolios with a core of global managers allowing them to cast the widest possible net from which to select the best possible opportunities for their mandate. This means our geographical allocation tends to move automatically based on manager preferences for certain areas of the market. We will then allocate to single country allocation managers should we have an underweight position that we would like to close. One example of this is our allocation to Artemis US Select as we are aware that it has historically been painful not to have a full allocation in this area. As you can see from the chart below, our equity blend portfolio currently has an allocation of c.34% to the US. Using the combination of global managers and our Macro research partner, TS Lombard, we will aim to allocate our clients to areas of the market with the best forward-looking returns.
As with commonalty of individual names between funds, review of overall sector positioning ensures the investment committee has the information to review whether portfolios are exposed to the right type of risks. Although we do not typically allocate to single sector strategies, with our managers having diversified portfolios, we nevertheless think it is important to have a good overall picture of where our risks lie. A recent example of this can be taken from TS Lombard analysis which indicated rising yields would see certain sectors such as Financials and Energy benefit in addition to more cyclical sectors which would benefit from easing of lockdown measures. In these scenarios it is valuable to be able to review current exposure to these sector allocations for future portfolio changes.
Have a good weekend,
The Tideway Team
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