Fidelity Sustainable Multi Asset Fund range portfolio manager Caroline Shaw examines the outlook for the year ahead
We expect central banks to have to tighten further if inflation remains sticky on the back of Russia’s invasion of Ukraine, and in the face of slowing growth prospects across most of the world.
In these circumstances, we would retain a cautious, risk-off stance and expect volatility to remain high as investors adjust to fast moving variables such as conflicts in monetary and fiscal policy, China’s growth prospects, as well as the longer-term impact due to rising commodity prices and climate change. The varying impact of these variables on different parts of the world will mean that tactical allocation will be an important source of value-add. However, we do think that this will lead to attractive opportunities to add to risk-on positions.
In these circumstances, the ability to remain nimble, react quickly to changes in markets and the ability to focus on finding secular growth opportunities will be key.
What could surprise markets in 2023?
Given appropriate policy support, it could be the European equity market that offers a positive surprise in 2023. Markets have severely corrected during 2022 and valuations are starting to look attractive in some sectors. For sustainable investors, Europe leads the way with sustainability standards, high levels of corporate disclosure and transparency and in the early adoption of a double materiality approach.
There are risks within Europe, not least the ongoing energy crisis and the war in Ukraine. Whilst gas storage levels look sufficient to cope with the imminent winter, based on reduced demand across Europe, it is next winter that appears less secure. We are therefore mindful of the bigger picture and long-term nature of the energy crisis solutions.
Positioning for what lies ahead in 2023
Listed alternative investments focused on renewables and infrastructure have been at the mercy of energy prices, rising rates and UK political (and fiscal policy) uncertainty from short lived policies through to leadership changes. From a sustainability perspective, renewable infrastructure investments are a key element in the transition to net zero and in energy security. From an investment perspective, the inflation linkage is an attractive characteristic, in addition to the differentiated sources of revenue. Experienced management teams running trusts with valuation cushions against higher risk-free rates look attractive for the longer term though we are mindful of the policy risks facing the UK given the economic backdrop and the politics of support for the energy transition in such an environment.
Being well diversified across both asset classes and underlying investments has been helpful during 2022. The key has been a cautious approach overall with lower equity exposure and lower fixed income exposure than during a typical year.
The offset has been higher than usual cash positions which we do not expect to sustain through 2023. We expect to see plenty of interesting investment opportunities to redeploy this cash into though the trigger for this is likely to be sight of the ending of rate hikes in the US and across Europe, and a change in the upward trajectory of inflation. With that in mind, we expect to have lower cash levels and higher equity exposure during 2023, reflecting more of a risk on environment.
Climate risks, most easily seen in changing weather patterns around the world, are hard to ignore. We anticipate greater recognition of the need to assess, understand and disclose climate risks and opportunities and embed these into risk management and strategic planning at company level. Preparedness for change will be one factor that will influence shareholder returns as this isn’t just about minimising climate risks
CDP, a global non-profit which runs the world’s environmental disclosure system, estimates that US$4 trillion worth of assets will be at risk from climate change by 2030. Importantly, its recent report based on US company disclosure identifies potential financial benefits of climate transition opportunities at least 15 times higher than the potential financial impact of the risks.
Within multi-asset, we expect increased levels of active engagement with our internal and third-party managers as we seek improved integration of ESG and climate factors in investment decision making, increased transparency, measurable data points and consideration of the management of ESG and climate risks, alongside pathways to net zero and recognition of the opportunities afforded by the transition. We believe our engagement efforts positively influence returns to our investors.
Hear more from Fidelity, a 2023 Dynamic Planner Conference Partner, live in London on Tuesday 7 February.
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity’s Multi Asset funds can use financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.
By Sam Liddle, Church House Investment Management
The current backdrop of rampant inflation, soaring energy prices driven by geopolitical tensions, and impending recession has provoked much talk of the parallels with the UK’s last big inflationary crisis in the 1970s.
Back then, the retail price index peaked in 1975 at almost 27%, following chancellor Anthony Barber’s ill-fated 1972 ‘budget for growth’ under Edward Heath’s Conservative government and OPEC’s 1973 oil embargo.
Such comparisons – particularly with the ‘Barber Boom’ that fuelled wage rises and inflation – have become more meaningful in the aftermath of this year’s so-called Mini Budget announced in September by chancellor Kwazi Kwarteng, which sent sterling plunging to all-time lows against the dollar, and gilt yields soaring.
A more useful comparison
While the economic parallels between now and the 1970s make for illuminating (and alarming) macro commentary, it is also useful to consider their ramifications at a more granular level, for the value of asset classes held by UK investors.
The focus for investors was notably different back then, as there were no corporate bond or index-linked gilt markets; we are therefore concentrating on the impact for gilts, cash and equities, drawing on the Barclays Equity Gilt Study for the 20-year period between 1965 and 1985.
It is worth setting the scene by looking first at the corrosive effect of inflation on the buying power of sterling over that time. A lump sum worth £100 in 1965 would have bought only around £10 of goods in 1985. Clearly, then, those who simply held cash under the bed suffered huge losses over the two decades.
Fixed interest pain
What happened with government bonds? Yields rose from around 6% in 1965 to peak at 17% in 1974, falling back to around 10.5% by 1985; Barclays calculates that the total real return, taking account of capital values over those 20 years, amounted to -0.3% a year on a total return basis.
But perhaps a more useful analysis is to consider what would have happened to £100 of gilts bought in 1965 and held with gross interest reinvested. That £100 would have practically halved in real terms by 1974 as yields went through the roof and decimated capital values, but it recovered much of its value through the early 1980s.
Cash savings tread water
Barclays looks at returns from both UK Treasury Bills and building society accounts, which were a much more important feature of household savings in the 1970s. It finds that over the 20-year period Treasury Bills broke even in real terms, while the higher interest rates paid on building society accounts meant they achieved an annual average return of 0.3%.
But again, that long-term average masks the real losses suffered by building society savers through most of the 1970s as a result of inflation. By the end of the decade, a £100 deposit with gross interest reinvested would have bought just £85 worth of goods compared with 1965.
UK equity investors had a torrid time during the bear market of April 1972 to December 1974. Share prices fell by more than 70%, compounded by a secondary banking crisis, falling pound and industrial unrest as well as the oil crisis and inflation.
Total return data for the FTSE All-Share index was not available until 1984, but the Barclays study (which runs an index based on data from 1899 onwards) shows massive swings in real equity values between 1965 and 1985.
Indeed, such was the impact of the 1972 slump that as of December 1974 the total real return for the previous 10 years was running at an annual average of -7.3%. But the subsequent recovery in share prices into the 80s meant that over the total 20-year period equities pulled off an average real return 5.4% per year.
To relate that to our £100 lump sum, if it had been invested in 1965 in the UK market with dividends reinvested, its real value would have plummeted to just £50 by the end of 1974, before soaring to well over £250 by 1985.
What is the takeaway?
Terrifying volatility, accompanied by many corporate and individual bankruptcies, was the price paid by equity investors for the best long-term real returns.
Closer examination of leading blue-chip companies in 1965 shows that a large number either went bust or were taken over during the following 20 years. The evidence backs up our ongoing concerns that capital-intensive, low-margin businesses are particularly vulnerable to inflation and rising interest rates.
More generally, it is encouraging to note that a focus on equities paid off over this period – but cash resources were vital to the survival of both companies and investors. The lesson remains that the surest protection for investors in such turbulent times is provided by holdings in high-quality companies with strong balance sheets and margins that can survive a significant downturn.
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The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article.
Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.
By James Mahon, Joint CIO, Church House Investment Management [27 Sept 2022]
September saw a further deterioration in markets, culminating in a disorderly end to the period with steep falls for equity and bond markets, and the makings of a currency crisis.
The US Federal Reserve raised the Fed Funds Rate by 75bp (now up to 3.25%), the European Central Bank (ECB) also raised by 75bp, while the Bank of England limited itself to 50bp (in a split decision), though, to be fair to the Bank, it was the day before the new UK Chancellor’s fiscal package (not to call it a mini budget).
With the accompanying tough talking from the central bankers, bond prices slumped and yields rose along the curve. The major central banks are continuing to signal that more tightening will be needed to bring inflation back to target, while admitting that an economic contraction is a means to this end.
The US yield curve has fully inverted now, the two-year yield rising to 4.3%, 10-year to 3.8% and 30-year to 3.7%. A mild recession in the US looks likely now. The ECB’s hawkish tones confront a European economy already in recession.
The UK Chancellor’s package delivered even more tax cuts than had been trailed, the lack of an accompanying budget or plan to pay for all these cuts quickly led to a focus on the potential inflationary effects, higher yields and weaker sterling.
Gilts have taken a hammering in recent days with the two-year yield jumping to 4.4% and the 10-year to 4.25%. The effect of duration on longer dated issues has been dramatic: the 30-year Gilt has fallen a further 30% in value over this past five weeks, taking it to a fall of 56% over the year. This is what ‘normalisation’ looks like when played out at pace. We are now back into the yield range that persisted from 1998 to 2008.
Equity markets have followed suit with falls of around 12% for the S&P 500, taking it back, almost exactly, to the end-June low points. All the major world markets fell, the only gainer was volatility. Interestingly, though possibly not a surprise, the price of oil has also fallen back along with metals prices.
It is still all about inflation. In the short-term, consumers and businesses are to be shielded from the prospect of massive jumps in fuel prices (though these are abating somewhat), which will provide significant relief. We expect inflation to begin to abate over the next six months, but remember that it is a lagging indicator and what matters to the markets is the time when they can see that the Federal Reserve really means what it says.
Europe was in the eye of the storm of gas prices and Putin. Now the storm has crossed the channel to the UK. Falls in sterling are inflationary (though much of this has been US dollar strength). A tax-cutting budget can be inflationary (unless the cuts can really be covered). Both increase the odds of a tougher response from the Bank of England.
The better side of the coin is that, for the first time in years, one can see decent returns on offer in the Gilt market and even better returns on offer in credit markets.
My suspicion is that markets (fixed interest and equity) have priced-in a lot of bad news and that fortune will favour the disciplined buyer of quality companies now. But, in the short-term, it feels like it could go anywhere.
By Bordier UK
The FCA has now published its final Consumer Duty rules, with a definitive implementation date set for July 2023.
There is now no excuse for adviser firms to have not begun their preparations, especially given that a firm’s board (or equivalent) must have agreed and signed off on their Consumer Duty implementation plans by 31 October 2022.
The FCA’s new outcomes-based approach focuses on ensuring adviser firms always put good consumer outcomes at the centre of their business and that they focus on the diverse needs of their customers at every stage. Included in the new rules is a new consumer principle, which is underpinned by four expected outcomes:
- Products and services: ‘Fit for purpose’ – Advisers should be recommending products and services that are clearly designed to meet the needs of the customer and their known objectives.
- Price and value: ‘Fair value’ – Advisers should ensure customers are paying an appropriate fee for the service provided and that they are getting value for money.
- Consumer understanding: Customers must be enabled to make informed decisions about products and services. This includes the timing of information, and how it is delivered.
- Consumer support: Customers are supported by the firm to realise their financial objectives and realise the benefits of products they buy. The support should be delivered by channels that the customer wants, not what the firm chooses.
‘Fit for purpose’
Whilst many advisers should now be aware of the incoming principle, they may not necessarily appreciate the greater governance requirements for ensuring the products and services they offer their clients meet the needs of the target market and, most importantly, work as expected.
Throughout the FCA’s review, they highlighted several areas of poor practice where customers could receive a poor outcome. One particular area was the recommendation of ‘products and services that are not fit for purpose in delivering the benefits that consumers reasonably expect, or are not appropriate for the consumers they are being targeted at and sold to’.
The higher expectations for adviser firms regarding ongoing suitability and expected client outcomes has shined a greater light on an adviser’s chosen investment solutions and whether those propositions truly support clients in achieving their financial objectives, particularly with regard to clients in drawdown.
Centralised propositions and Consumer Duty
The introduction of Consumer Duty has signalled just how important it is for a firm to have a robust governance process, documented in a clear and concise PROD document, demonstrating client segmentation and how the chosen investment propositions meet the needs and characteristics of their target market.
It is evident that a substantial proportion of adviser firms (just under 78% based on research from Aegon) have an established centralised investment proposition (CIP) for clients accumulating wealth. It may come as no surprise that many advisers are confident that their current CIPs meet many of the product governance requirements of the incoming Consumer Duty through existing processes as a result of PROD.
However, with over 60% of adviser assets on average linked to clients receiving retirement advice (according to research from NextWealth), it is surprising that only around 50% of firms have implemented a centralised retirement proposition (CRP). This begs the question as to whether an adviser’s current investment solution for clients in or nearing retirement is suitable and provides the right outcomes for clients drawing a regular income.
This is often reflected in adviser investment propositions, with at times minor variation between an adviser’s CIP and their solutions for clients in retirement – the same risk profile often kept for both, which may be appropriate but could have some short comings depending on the adviser’s chosen investment solution.
What the new consumer principle brings into focus is whether those accumulation strategies and the maintenance of a client’s risk profile, are now providing the right outcomes for clients who need to preserve capital and manage their stock market risk whilst taking a regular income.
A different approach needed
Creating a CRP can be challenging – as clients move from accumulation into decumulation, advisers have to deal with much more complicated decisions and associated risks. Drawdown is complex and there are many challenges of managing clients who are drawing a regular income, in particular, the management of sequencing risk.
These added complexities have been masked by a decade of strong market performance; as a result, some advisers have maintained a more traditional accumulation approach to clients in drawdown. This often entails retaining a client’s existing risk profile on reaching retirement, which may not be the best approach to meet the client’s required outcome.
The conversation around the risks in drawdown (sequencing risk included) needs to be reframed. Advisers should shift their focus from growth-driven accumulation to investment strategies that put capital preservation first for clients in retirement, who need to ensure their retirement provisions can meet their income needs throughout their retirement with reduced market volatility and without the timing of their withdrawals significantly impacting the size of their pot.
Sequencing risk remains one of the biggest dangers facing client portfolios in drawdown and recent market volatility should focus the minds of advisers on the impact it has on investments. Greater focus should, therefore, be placed on managing risk within the client’s portfolio to reduce the fluctuations in its value to ensure the impact of withdrawals is minimised. This can be achieved by assessing risk on a monthly basis (as opposed to an annual one) against specific ‘value at risk’ boundaries, a more forward-looking measure, to help assess potential max drawdowns.
A client’s investment objective in retirement is also likely to be fundamentally different – many switch their focus from investment returns, to maintaining a regular income and a smooth investment journey. This aspirational change could in turn alter the underlying asset allocation, expected return profile and the management of risk within their portfolio and should, therefore, be reflected accordingly.
Adopting an active risk management approach in decumulation, to ensure the level of risk within a client’s portfolio is not only appropriate but also proactively managed to help provide a smoother retirement journey for clients, is an ideal solution.
This dovetails with the consumer principle and is a prime example of meeting the needs of the client. This approach can also assist and provide assurance for advisers with their ongoing client suitability.
Not long left
Now that the final rules have been published, and with the new consumer principle due to come into practice next year, adviser firms should be looking at their investment propositions to identify any gaps in their existing processes and ensure that they are delivering good outcomes for their client – those in accumulation as well as decumulation.
- If you require help with building your centralised retirement proposition, or are looking to manage both client and business risk through a risk-targeted approach, please contact Mark Duggan on 0207 667 6600 or at email@example.com
By Sam Liddle, Sales Director, Church House Investment Management
Whether it’s shifting interest rates, soaring inflation, or heightened geopolitical tension, there’s a lot of short-term risk and uncertainty on the table right now.
The reality is investors are quite right to be cautious – a look at the volatile performance of any major index since the beginning of this year alone can show you that. With all this in mind, it’s hardly surprising that in May, Bank of America reported the average cash holding of a global asset allocator to be at its highest level since 9/11. But should this really be the case?
A major part of any investment professional’s job should be to see the forest when the rest of the market sees the trees. As Warren Buffett, the Sage of Omaha himself, once said: “Be fearful when others are greedy and greedy when others are fearful.”
With so much value on the table in today’s period of economic retraction, there’s a strong argument to be made that right now is the time for investment professionals to be brave. Indeed, rather than hide in cash, these individuals must instead ask themselves a critical question: what can I do today that my clients will thank me for in five years’ time? I suspect in this inflationary time, the answer won’t be, ‘sitting in cash.’
It’s difficult, but rather than peering into the seemingly bottomless abyss of bad news, we should lift our heads, look across to the other side, and consider what opportunities we can exploit in the current volatility.
The bottom line is markets are cyclical. That doesn’t mean they are easy to predict, but it does mean they tend to follow a sequence of stages over time. It’s the macro events that are unknown and that trigger the move from one stage to the next.
After a prolonged period of ultra-loose monetary policy and escalating equity valuations, a move from market “euphoria” into bearish territory was inevitable coming into 2022. However, it’s clear now that post-pandemic inflation, central bank tightening, and uncertainty around the Ukraine crisis were together enough to catalyse the beginning of this transition.
While the days of simply investing in something indiscriminately and watching its value rise may now be over, markets have made this transition time and time again throughout history, and every time, it has been possible to enhance returns by choosing the right investments while they were trading at a discount.
The idea that bottomed-out markets offer an opportunity to scoop up bargains to maximise upside potential is no doubt an attractive one although, in practice, this approach is by no means easy.
Increasingly short-term reporting requirements and a natural tendency to focus on the news headlines rather than individual stock fundamentals tend to make us blind to opportunities or shrink from making the bold call to invest.
Maybe it’s the memory of that saying from 2001 that a stock that’s fallen 90% is one that fell 80% and then halved. Whatever it is that deters us, being greedy when others are fearful isn’t easy, but you wait, at some point after markets have recovered some smart aleck will tell you, ‘The easy money has been made’.
Making the best of it
There’s no question that the responsibility of managing someone’s money can be a daunting one at a time when everything seems to be collapsing in value. However, it’s important to keep perspective and take Warren Buffet’s advice – markets have recovered many times before and they will again, but you can’t partake in a market recovery if you’re invested in cash.
It’s critical to stick to the fundamental principles of investing and leverage today’s weakness as an opportunity. Always asking oneself: what can I do today that my clients will thank me for in five years’ time?
Find out more about Church House Investment Management funds.
The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article. Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.
By Cantab Asset Management
The last decade has seen significant asset price appreciation, accommodated by expansionary monetary policy. Alongside this, periods of uncertainty have led to spikes in volatility. Whilst recent levels of Quantitative Easing are unprecedented in historical terms, volatility and market corrections are not. This note considers the relationship between active management and market volatility in the context of achieving strong long-term performance. The main takeaways from the following analysis are:
- The actively managed funds tended to exhibit higher volatility than their passive peers
- Over each period of heightened volatility, the actively managed funds tended to outperform their passive peers
- Over the full period, the actively managed funds all materially outperformed their passive peers
- Despite higher levels of volatility, the actively managed funds tended to prove more resilient than their passive peers from a maximum drawdown perspective. This demonstrates one challenge associated with relying on volatility alone as a measure of risk – it captures upside as well as downside movements
- Similar results were obtained when comparing the actively managed Cantab multi-asset portfolio to a passive peer
The VIX index is used by investors as a measure of implied volatility in financial markets. It is based on S&P500 option prices and is commonly referred to as the “Fear Index”. Between 2018 and 2021, the VIX has breached level 20, which is considered to be ‘high’, on four occasions, as illustrated below.
Each of the four highlighted periods captures a date range in which the index level moved from low-to-high-to-low and is used as a proxy for short-term market volatility. Performance during these periods is illustrated below, alongside commonly-used risk metrics for three actively managed funds and their respective passive alternatives.
These findings may or may not be representative of the entire active universe of funds; to test them is beyond the scope of this analysis. What is clear however, is that within the universe of actively managed funds, there are options that provide significant outperformance on a risk–adjusted basis during periods of heightened volatility. It is our role as advisors to identify and monitor these.
When applying the same analysis to the actively managed Cantab multi-asset portfolio, not only did the portfolio outperform its passive equivalent over the full period but also achieved relatively similar volatility and max drawdown metrics overall. The analysis also found that after a material peak-to-trough movement, the actively managed Cantab portfolio recovered considerably faster to previous highs when compared to the passive equivalent.
The results from the analysis not only highlight the importance of taking a long-term view, but also demonstrate that there are two sides to volatility: downside and upside. Volatility is usually calculated using variance or standard deviation, by summing the square of the deviation of returns from the mean return and dividing by the number of observations in the data set. By definition, upside and downside deviations are treated equally. Whilst higher volatility implies higher risk, due to less predictability of asset pricing, investors are typically in favour of upside volatility in practice. By pursuing a passive strategy, investors avoid the downside risk of underperforming a benchmark index; unfortunately, they also miss out on the upside potential of outperformance.
Periods of short-term volatility have been common throughout history and will continue to be common in the future. However, during such periods, investors tend to focus on the negative side of volatility rather than directing their focus to the bright side of volatility that is offered by good active management.
- Both the start and end dates for each of the respective volatility periods were obtained by identifying the lowest VIX level before and after breaching level 20. A VIX level of below 12 is considered low, a level exceeding 20 is considered high.
- The Vanguard fund was selected based on similar equity exposure to the Cantab portfolio for comparison.
- Cantab’s Managed Portfolio Service (MPS) performance data is presented net of 0.36% pa MPS fees which do not attract VA
This content has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.
By Sam Liddle, Sales Director, Church House Investment Management
For a long time, the 60/40 approach to portfolio management was perfectly effective. Offering a combination of equity-like returns and stable income, it allowed investors to participate in any market upside, while at the same time offering protection during periods of volatility. Simple. However, the approach has faced snowballing criticism over recent years in the face of unprecedented market performance.
Well, over time, as the value of each asset in a portfolio shifts in line with its performance, its size within the total portfolio in percentage terms will naturally also change. To keep the 60/40 split between equities and bonds in check, then, it becomes necessary to sell overperforming assets and add to underperforming ones periodically.
In and of itself, this is not a problem. In fact, rebalancing in such a way is good practice –working to reduce concentration risk and prevent emotion-driven decisions like panic buying and euphoric selling. And in an ideal world, the underperforming assets into which the investor re-invests would see an uptick in performance, enhancing total portfolio returns and smoothing out volatility.
The issue, however, is that this hasn’t been the case at all in recent years. We have seen unprecedented global central bank support since the global financial crisis in the form of interest rates and other initiatives designed to aid economic recovery.
On the one hand, this has consistently suppressed bond yields, leaving them stuck at just a fraction of the level at which they have typically sat historically. On the other, it has enabled equity prices to soar to new records, with valuations stretching to levels consistently highlighted as unsustainable by commentators.
As you’d imagine, maintaining the 60/40 split against this backdrop has consistently required investors to sell off overperforming equities and invest in underperforming bonds. And in the eyes of many, this has been akin to throwing good money after bad, effectively wiping away returns time and time again for no good reason.
So, while the 60/40 approach may not have generated the best returns in recent years, is it fair to classify it as ‘dead’? No, we don’t think so. And the reason why is that things are now changing seismically in the market.
The tremendous injection of liquidity by central banks throughout, and in the wake of, the pandemic has pushed inflation to unsustainable, multi-decade highs worldwide. As a result, those same central banks are now being forced to increase rates in earnest to steer clear of hyperinflation.
Likewise, we are now seeing institutions like the Bank of England and the Federal Reserve move away from their roles as the de facto buyers of corporate debt. In some cases, they have even begun to unwind their recent purchases back into the market.
There’s an argument to be made, of course, that the ongoing conflict in Ukraine is slowing this tightening of monetary policy. But this will only be temporary – higher rates and tougher stances are an inevitability over the long term.
And for many investors, the move away from the seemingly endless ‘growth’ phase that has favoured equities and hurt bonds for so long and into the ‘slowdown’, ‘recession’ and ‘recovery’ phases is going to come as quite a shock.
Indeed, there’s a good chance that we will see heavily stretched equity valuations come into question as rising rates continue to elevate bond yields. And if this takes place, then something closer to the 60/40 approach – with its emphasis on income alongside growth, may suddenly become much more effective.
Yes, there have been significant losses for some bond investors so far this year but by proactively protecting holdings, either through curve positioning (the duration), credit quality or more explicit interest rate hedges via floating rate bonds, is crucial to getting the fixed income element of portfolios right.
Government benchmark yields have risen sharply and holders of too much duration have certainly paid the price. But bear in mind though the opportunities that this readjustment has created through a combination of the increase in the ten-year gilt yield (discounting a move to 1.5% in UK interest rates) and the widening of the credit spread above that.
Only a few months ago, the short end of the gilt curve was almost negative, now we have two-year gilts offering a mighty 1.3%. Not that attractive in itself, but when you add a credit spread on top, you can access a fair yield on a total return basis. There are now a number of quality bonds, issued last year when yields were low, that are trading well below par.
The 60/40 approach to portfolio construction was unquestionably of limited effectiveness throughout the enormous post-millennium equity bull market. However, to describe it as ‘dead’, as many commentators have, is so definitive. After all, it promotes a responsible approach to asset allocation that accounts for both growth and volatility. And in a world where many indicators suggest we are moving towards a more depressed stage of the market cycle, this is becoming increasingly invaluable.
Find out more about Church House investment solutions.
First published on Trustnet. The above article has been prepared for investment professionals. Any other readers should note this content does not constitute advice or a solicitation to buy, sell, or hold any investment. We strongly recommend speaking to an investment adviser before taking any action based on the information contained in this article. Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.
By Brooks Macdonald
Several major global events – including most recently the coronavirus pandemic and the Russia/Ukraine situation – have prompted investors to flee financial markets, but history shows this could have been a mistake. In this article, we discuss the importance of remaining invested and how missing the best performing days could have led to a portfolio’s significant underperformance over the long-term.
What potentially seems a distant memory, the stay at home orders and dystopian feel to everyday life sent shockwaves through financials markets at the start of 2020, as a result of COVID-19. More recently, Russia’s invasion of Ukraine has rocked markets. In such conditions, it may be tempting to consider exiting the financial markets or switching to cash, with the intention of reducing further expected losses.
Trying to time the market can seriously damage your investment returns
Amidst heightened volatility, it is understandable that many are concerned about the impact on the value of their investments. But, while sharp declines in markets can naturally be disconcerting, if you want to give your investments the best chance of earning a long-term return, then it’s a good idea to practice the art of patience.
When markets fall and fear dominates, it can be difficult to resist the temptation to sell out of the financial markets and switch to cash, with the idea of reinvesting in the future when feeling more positive about market prospects – trying to ‘time the market’. But this is a strategy that carries with it the risk of missing out on some of the best days of market performance. And this could have a devastating impact on long-term returns.
Remaining invested may be an emotional rollercoaster during times of market stress, but research shows time and again that this is the best investment approach over the long term. For example, one study of US equity mutual fund investors showed that their tendency to try and time the market was a key driver of their underperformance (Dalbar, 2019)1. In the current environment, it is understandable that many people are concerned about geopolitical risks, and how this is being reflected in the value of their investments. To give some context, the speed at which the market entered into ‘bear’ territory (typically a 20% decline) in response to the coronavirus pandemic was the fastest in history. The current sell off does not qualify as a bear market but has dropped 10% since recent highs as shown in the chart below.
1 Dalbar (2019). ‘Quantitative Analysis of Investor Behaviour
Despite temptations to switch into cash, data shows that missing out on just the 10 best market performing days can have a big impact on long-term returns.
Staying ‘fully invested’ during the ups and downs has resulted in an initial £100,000 portfolio, for example, having an ending value of £445,000, compared to £250,000 for those that missed the 10 best days in previous 20 years. This effect also highlights the powerful effect of ‘compounding returns’ over time. If, for example, the 50 best days are missed, the long-term returns are indeed negative.
A different way of delivering the same message, where staying invested over the 20-year period generates annualised returns of 7.9%, compared to 0.8% annualised returns if one misses the 30 best days:
One of the most common reasons investors lose money is when they try to time the market, trying to avoid the worst days of the stock market by cashing out and then re-investing when they think the market is going to pick up. However, as the chart shows, the best and worst days of the stock market cluster. Try to miss the lows and you’ll probably miss the highs too.
Missing the best days during the downturn and subsequent upturn can again have a large impact on the returns generated over the subsequent period.
With the benefit of hindsight, we are now fully aware of the global impact of COVID-19, and the rapidity in which it has hit equity markets. While markets rivalled the speed of the virus in trying to price-in the near-term damage, we expected they could also be swift to act when a tipping-point was seen to be close- at-hand. World equity markets returned to highs around 120 days following 2020 lows.
By keeping to an established and proven investment framework, we can look to take advantage of short-term volatility as we continue to seek out longer-term investment opportunities. We look to avoid behavioural biases that may result in decisions that negatively impact long-term return potential. Yes, the journey may not be smooth, but generally it is important to look through the noise, and remain invested during times of market stress.
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Our investment team discuss how we are evolving and enhancing our sustainability research and ratings. Find out more about how we are moving away from solely using ESG as a risk management tool, with an increasing focus on delivering real world change.
In recent years, we have seen rapid growth in interest in sustainability and rising desire for sophistication from investors in how it is approached. Today, investors are increasingly looking to influence positive change by directing capital to address ESG problems, not least climate change.
As part of this evolution, we have developed the core tools within our sustainable research platform, making enhancements. We have evolved our ESG ratings and version 2.0 now makes more in-depth assessments of how companies are managing the impacts of their businesses and mitigating any negative effects on all stakeholders, including workers, society, the environment, etc. We are also measuring alignment with the SDGs and how companies are making positive contributions to these goals; as part of this, we try to disaggregate different activities to provide more granular information.
Broadly speaking, what we are doing is moving away from using ESG as a risk management tool that contributes solely to financial outcomes. Instead, we are moving towards an approach focused on delivering real world change. It means much more holistic assessments of the opportunities and risks faced by an issuer, as well as more forward looking.
The first stage in our process regards materiality mapping – we have developed customised materiality maps for 127 individual industry subsectors, each with a different weighting combination of 14 social and 26 environmental indicators. These maps are determined by our research analysts alongside our dedicated sustainable investing team on the basis of each company’s operations, but also the context of their impact on other stakeholders, such as suppliers and broader society. For example, we would include Scope 3 emissions linked to airports, whereas other ESG ratings might not.
Our extensive corporate access enables us to engage with corporates to investigate sustainability issues in great depth. This is a key differentiator – we use a combination of qualitative and quantitative inputs, rather than relying on publicly-disclosed quantitative data as many external rating systems do. Our qualitative assessments are undertaken by our analysts, who have detailed knowledge of the companies in their coverage.
We are lucky to have relationships with and access to senior management teams all around the world that enable us to take this approach, it is not something that every firm can accomplish. Our local research teams are able to engage on ESG issues with countries in all cultures and languages in order to drive improvements in their behaviour.
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This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. A focus on securities of companies which maintain strong environmental, social and governance (“ESG”) credentials may result in a return that at times compares unfavourably to similar products without such focus. No representation nor warranty is made with respect to the fairness, accuracy or completeness of such credentials. The status of a security’s ESG credentials can change over time. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.
By Louisiana Salge, Senior Sustainability Specialist, EQ Investors
Whilst the number of investors who would like to make a positive impact to society and the environment continues to grow, we still encounter misconceptions that prevent some from taking the plunge. This piece dispels some of the common myths associated with sustainable investing.
Misconception 1: All sustainable investment approaches are the same
There are a variety of ways in which sustainability considerations can influence investment mandates and portfolio management. To summarise the three most common approaches:
Traditional ethical investing focuses on excluding a set of industries or companies based on controversial behaviour, often called the “sin stocks”. Investment strategies will apply a values-based negative screen on industries like tobacco, alcohol, or pornography. The rest of the strategy is then managed with traditional investments.
ESG investing introduces information on how well companies manage relevant operational Environmental Social and Governance (ESG) factors into the investment decision-making. Investment strategies can integrate this information differently. Common approaches may overweight or set inclusion thresholds based on company ESG performance, relative to peers. This approach usually overlooks the analysis of companies’ products and services.
Impact investing focuses on creating material, measurable positive impacts on people & planet. Instead of being a relative assessment, such as ESG, the focus here is on maximising the absolute positive impact associated with investments. Investment strategies can do this by positively targeting sustainable themes like clean water, renewable energy, or accessible healthcare. This approach puts a very strong emphasis on companies’ products and services and the solutions they bring to the many challenges we face.
Misconception 2: Sustainable investing will sacrifice investment returns
There is mounting evidence that sustainable investing does not sacrifice performance, in fact, incorporating ESG factors into investments can help boost financial performance. Overall, businesses that demonstrate greater operational sustainability (ESG) and sustainable products & services, can perform better.
Evidence indicates that the positive correlation between sustainability and performance holds both at the corporate accounting, and investment performance level. The reasoning is that businesses managing E, S and G better than peers demonstrate better risk control and compliance, suffer fewer severe incidents (for example, fraud, environmental spill litigation) and ultimately carry lower tail risk. ESG leaders invest more in Research and Development, foresee future risks and plan ahead to remain competitive.
Impactful companies are those that have turned the largest societal challenges into profitable business opportunities. These companies benefit from the growing global demands for their products and services, greater regulatory support and from avoiding reputational and stranded asset risks.
Misconception 3: Sustainable investing is too risky
It is true that many high-impact investments can be in more volatile markets (such as emerging markets), but real opportunities exist across all asset classes, from small to large companies located in the US, in the UK and all regions of the world – and risks vary between these. For example, social housing investments can provide reliable government backed income streams while providing significant societal benefits. Water utilities prevent industrial wastewater from polluting natural ecosystems and provide defensive investment characteristics.
Therefore, portfolio managers like EQ Investors can adhere to normal risk categories and create portfolios for different ‘risk appetites’, as well as tailor these to sustainability preferences.
Misconception 4: It is a narrow investment universe
There is no single defined investment universe for impact investors. Investor preference defines the opportunity set by deciding on risk, return and impact theme targets. The amount of companies eligible for investment can depend on the impact or ESG standards set by investors.
While this means that we can’t give a reliable impact universe estimate, opportunities are larger than some might assume. For example, the EQ Positive Impact Balanced Portfolio has exposure to about 1,000 unique companies and organisations globally.
This universe is also expanding. As much as investor interests are turning to sustainability, companies’ business models are too. In 1999 Impax Asset Management had an investment universe of 250 companies which generated more than 50% of their revenues from environmental solutions. This universe has now grown to about 1,400 companies. The same would apply to the healthcare, financial inclusion and education universes.
Misconception 5: Sustainable investing cannot make a positive impact
When investing through traditionally managed portfolios, disregarding the impact of investments on people & planet can contribute to business activity that actively works against the client’s values. On the other hand, investing a client account through a positive impact mandate, the output of companies and that associated with an investment can align with the client’s values.
Even in listed markets, allocating equity capital or investing in bond issues of businesses that create positive sustainable impact, will support their share price, and provide easier access to capital thereby producing a license to operate. Using capital to invest for positive impact will signal to the market that such non-financial impacts are valued and nudge laggards in the right direction.
Sustainable investors will use their company relationships to engage boards on any sustainability weaknesses and thus create change. They are also able to use voting rights to back or block strategic decisions that concern the company’s ESG performance.
The dual objective to create financial and sustainability outcomes means that the investment reporting that private clients receive should not solely cover the financials.
At EQ Investors we invest significant resources to bring the impact that our portfolios have “to life” and demonstrate that we are delivering on our clients’ positive impact objectives. For example, we have created an interactive impact calculator that shows the investments’ associated positive impacts, like renewable energy generated or hours of education provided. We also transparently disclose alignment with the UN Sustainable Development goals, and how portfolios are aligned to climate change scenarios.