Since the last financial crisis, traditional asset classes have become hugely distorted for various reasons. Initially the price of bonds, the perceived lower risk asset class, became hugely inflated as central banks around the world started buying these assets with newly created money, or Quantitative Easing in economists’ parlance.
As the yields from bonds fell, investors buying assets for income were forced into other areas, in turn making them more expensive. The so called bond proxy stocks, large well capitalised companies that display bond like characteristics, became the next target as money trickled down from bonds.
More recently, other events have created further distortion in investment markets, most notably the vote for Britain to leave the EU has caused sterling to collapse which has, somewhat artificially, increased the value of the FTSE100 as one-third of the dividends within the index are generated in dollars, which are now more valuable.
Across the pond, investment markets are riding high on the expectation that President Trump will boost economic growth through a focussed policy of investment on infrastructure to the tune of $1 trillion. This programme alone is estimated to increase GDP by as much as 0.6%* per annum.
Perhaps more significant are his proposed corporate tax reforms which, if enacted in full, could increase GDP by a further 1.6%* per annum. However, these “promises” are seemingly already baked into investment markets and so this leaves sterling investors in US/dollar denominated markets exposed on two fronts:
- Sterling could appreciate from what is a very low base and diminish returns on dollar denominated assets.
- Trump could disappoint with the breadth and scale of his pro-growth promises, sorry ‘policies’, and markets would re-price accordingly.
So with traditional asset classes looking expensive and facing a number of different risks, where do we look for real returns over and above inflation……..What are the alternatives?
One area that we like is multi-asset ‘Targeted Return’ funds where the managers are trying to achieve modest returns of 3-5% per annum over and above cash and irrespective of wider market conditions. This is attempted through a highly diversified portfolio, where the managers have the freedom to use strategies that can profit from prices falling (short) as well as prices rising (long) and quite often these strategies are paired together to reduce potential portfolio volatility. Think of these investments as hedge funds but without the ability to borrow to invest, and with the comfort of knowing that these are regulated by the FCA and deal on a daily basis.
The other area we are exploring for clients is more of a thematic equity approach, so still investing in shares of companies but through a fund with a strong theme that we buy into, rather than a wider remit to find good companies across any sector which can ultimately lead to a certain amount of tracking the market. An example of this approach might be a fund focussed on international brands, where the manager sees value in investing in companies that produce small ticket non-discretionary consumable items such as washing up liquid or toothpaste. It’s easy to see the investment case but these companies are not cheap for obvious reasons.
Increasingly we are looking for more specific themes to compliment our portfolios, provide additional diversification and in doing so (hopefully) reduce the total risk for our clients. An example of this approach is water. We all need it for drinking, washing, cooking, cleaning, but it’s the less obvious and more intensive uses that underpin the investment case. For example, it takes 4.5 litres of water to produce a single almond, 10 litres to produce one sheet of plain A4 paper, 32 litres to produce 1 microchip, amazingly 11,000 litres to make one pair of jeans and an astonishing 16,000 litres for every kilogram of steak!** It is therefore easy to see how companies that are involved in the supply, transportation and sanitisation of water could be well placed to generate consistent and repeatable returns that are less correlated to the direction of traditional investment markets.
Given the uncertain political and economic backdrop, coupled with the distortion in traditional markets, we are looking to include alternative and thematic assets as potential sources of income and growth for our clients, which at the same time can potentially increase diversification and reduce total risk across our portfolios.
*Source – Smith & Williamson, **UNESCO, Waterstat, UNFAO, IFPRI
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.