MPS Asset and Investment Allocation Update

Macro Investment Strategy

Whilst we are mindful that some risks are increasing, we feel our central case of preferring equities to bonds, and the US over other developed market equities remains intact.

The uptrend in EPS still fundamentally underpins the progress we have seen in equity markets. Global 1 year forward earnings growth has accelerated to 7.7% year on year up from a low of 5.8% in early March. We think valuations, which are often cited as a key concern for equity market investors, are undemanding - for example, world equities trade a forward PE multiple of 14.6x, which is below the recent high of 16.6x at the beginning of 2018. Equity valuations also remain attractive compared to the other main asset class in investor’s portfolios – bonds. Earnings yields for US equities is still over 5 compared to the yield on a 10 year treasury bonds which is currently only just over 2 – that is a historically wide margin. Softening monetary policy in the US is also a big tailwind for equities and goes a long way toward offsetting concerns over global trade.

We are concerned about global economic growth and pay closer attention to declining levels of Manufacturing Purchasing Manager’s Indices around the world. We note that Services PMIs are holding up however. Some of our proprietary quantitative indicators such as the Bear Market Warning, which uses a variety of market and economic variables, are indicating increasing risks, but has not yet crossed above a threshold where a forthcoming bear market is more likely than not. There is considerable political risk in the UK posed by the ongoing Brexit situation, and for that reason we continue to prefer overseas opportunities to those in the UK.

Managed Portfolio Service Asset And Investment Allocation

The MPS Team are aware of how long this economic cycle has persisted, and a number of the geopolitical risks we monitor have been escalating of late; US/China trade dispute, Iran sanctions, European economic weakness combined with the Brussels leadership changes. We want to continue take advantage of shorter term movements in markets, whilst looking to avoid being over-exposed to assets which might deliver sub-par returns given known risk factors, including the medium term moderation in global growth, which we and the strategy team expect to see play out. In this connection please see the features below of the December and May rebalances;

Fixed Income & Alternatives - Whilst still underweight bond quality has been increased in Corporates since December, duration reduced, and overweight to government backed Index Linked bonds increased this year.

  • In December and May we added to Global Index Linked bonds, at the expense of High Yield & Corporate bonds, whose prices usually demonstrate more correlation with stock markets. Conventional High Yield bonds which formed about 3 - 5% of MPS allocations across the range in late 2017, retained in higher risk MPS portfolios through 2018, have been removed from the MPS entirely. In the remaining UK Corporate bond allocation, which is underweight across the range, we sold from Kames Investment Grade (for manager selection reason) which had a benchmark neutral duration +/-, has been replaced with a new BlackRock Corporate Bond which maintains ‘on average’ higher quality names and will always be in shorter dated bonds than the benchmark, reducing risk in rising interest rate environments
  • Maintaining maximum diversification characteristics, including introducing some newly added exposure to Emerging Market bonds. In contrast to High Yield bonds, EM Bond prices had been becoming more attractive over the 18 months running into December 2018. We also have a small off benchmark position in Sequoia, a specialist infrastructure lender, where we see income generation strong enough to merit inclusion on a risk-adjusted basis.
  • In Alternatives - MPS has seen strong contribution from BH Macro this year, held particularly for its ability to perform in risk-off phases, and in Commercial Property we retain a strong quality bias using primarily Picton Property Income.

Equities Developed - Defensive in UK, on domestic Brexit & political risk, monitoring our overweight to US closely following strong performance, especially in GBP terms, underweight Europe, and overweight Japan.

  • In Equities, we have looked to be dynamic, reducing defensive holdings in December (RWC and Janus Henderson UK Absolute), in favour of more directional participation. In May we trimmed BlackRock Smaller Companies following strong performance this year, on the basis both of manager change and also that we could be exposed to a widening of the discount in the event of a sell off. Our exposure to investment companies has been reduced, with Miton UK Multi-Cap Income being the main beneficiary.
  • We retain exposure to the low volatility holding RWC Enhanced Income, across all but the highest risk model, of between 3 and 5%, together with Henderson UK Absolute Return, meaning our actual exposure to the UK market in a sell off would likely be well contained.
  • Overweight to Japan, with the Yen often a beneficiary, rising frequently vs other currencies in market down turns.

Equities Developing – Overweight across Asia and EM, where prices are much weaker than US markets, following 5 years under-performance vs US Equities.

  • Recently switched from Fidelity Emerging to BlackRock Emerging Markets Equity Strategies, on the basis not only of some concerns around Fidelity’s 2018 Performance, but also that this fund offers more diversification benefits in combination with our core holding in Hermes Global Emerging Markets.
  • Maintaining maximum diversification using India and Russia in combination, whose economies and markets have inverse correlation in relation to the oil price, which itself tends to fall in an environment of slowing growth.

Source: Smith & Williamson Investment Management LLP and Refinitiv Datastream as at 31 July 2019

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DISCLAIMER
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. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. 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 writing.

Please remember investment involves risk. The value of investments and the income from them can fall as well as rise and investors may not receive back the original amount invested. Past performance is not a guide to future performance.

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