I wanted to advise you, however, that the last few months of 2021, and so far this year, have been one of the hardest periods I can recall for active equity managers.
Happy new year to you, your colleagues, clients and families.
We are looking forward to meeting you in the forthcoming Investment Committee (IC) meetings after a fantastic year of returns last year. Those clients investing in Balanced portfolios will have enjoyed returns of around 9% last year, which is well above the long-term averages for such solutions. We are pleased to have delivered returns ahead of capital market assumptions, cash and much of the competition. When you aggregate together both 2020 and 2021, despite all the turmoil that Covid and subsequent lockdowns have brought, returns are in line with those seen over the long term, which seems quite incredible.
I wanted to advise you, however, that the last few months of 2021, and so far this year, have been one of the hardest periods I can recall for active equity managers. The primary reasons for this have been the challenges posed by Omicron, lifting of bond yields and the threat of higher interest rates, rather than markets being driven by company fundamentals. This has ultimately seen a sell-off in companies deemed as high quality ‘growth’ in exchange for cheaper stocks and driven the short-term underperformance within the equity part of the portfolios.
Below provides a summary of the predominant short-term challenges faced within the equity part of your portfolios over this period:
- The portfolios have a bias towards small and mid-cap companies as we believe these companies will grow faster and outperform larger stocks in the long term. However, the aforementioned macro challenges have had a greater impact on domestically consumer focused businesses (which the mid and small cap end of the market is more exposed to), rather than large multinationals. The impact of this was most widely felt within the UK and US positioning. Interestingly, across the market, only about 10% of active UK equity managers outperformed in the IA UK All Companies equity sector in Q4 (similar figures in the US) given their smaller cap leanings and sector positioning.
- Sector leadership has also been a performance headwind. At the portfolio level we are tilted more towards quality companies and growing areas of the market, such as technology and consumer discretionary and away from industries that are more mature with weaker growth prospects and/or driven by macro-economic forces (e.g. Chinese demand for materials), such as utilities and mining. The UK market’s leading sectors in Q4 however were a strange mix of utilities, real estate and mining, with energy, consumer discretionary and financials amongst the main laggards.
- On a fund level within the UK, TB Amati UK Smaller Companies and Jupiter UK Mid Cap funds have had stock specific issues which has seen them lag, not only the larger cap market, but also their respective smaller cap benchmarks. We have reviewed both funds and retain conviction in them, their longer-term track records stand testament to the worth of these strategies. • On a fund level within the US, our core passive Vanguard strategy which tracks around 3,500 companies, underperformed the more frequently quoted, and larger cap S&P 500. We continue to like the fund’s more diversified approach and its slightly reduced reliance upon some of the US market’s technology related titans. Furthermore, it was at least pleasing to see our small cap holding, Artemis US Smaller Companies, outperform the wider small cap index.
In the last few weeks, the market is really under pressure from the threat of higher interest rates. Any companies deemed as high quality ‘growth’ names are being dumped by investors in exchange for cheaper stocks. In the US, the technology-focused Nasdaq Composite Index has fallen into correction territory as a sell-off in US Treasuries reverberated across global financial markets. The benchmark index holds tech behemoths such as Apple and Google parent Alphabet and is nursing losses from a record high hit in November to about 10%. Analysts typically consider a 10% fall from a recent high to mark a correction in markets.
The sell-off has been propelled by surging yields on US and UK Government Bonds, as investors dumped the debt in anticipation of tighter policy from the Federal Reserve and the Bank of England. The yield on the benchmark US 10-year Treasury note has climbed for seven consecutive days to 1.77%, notching its biggest rise since the Covid pandemic rocked US financial markets in March 2020. It started the year around 1.5%, which has been mirrored in the UK Government Gilts market (UK 10-year gilt yields have moved from 0.74% to 1.15% in one month) which have been some of the most aggressive increases in interest rates over the last 20 years.
We are currently exploring with fund managers whether this is a temporary change in market leadership (remember the Trump election in November 2016 when inflation stories dominated for about 4 to 5 months) or a more permanent shift; and if it is the latter, what they are doing about it.
We revisited all the fund holdings with our analysts a week before Christmas to check whether we still hold the highest conviction bets – the answer was a unanimous “yes”. I am, therefore, not concerned about the holdings or our positioning but if this becomes a longer-term shift away from high quality companies then we will struggle on a relative basis for a while. However, we are far from complacent and are very focused on ensuring that we have the right solutions and funds to succeed over the next 3 to 5 years and beyond and we will not hesitate to make further changes if these are needed.
It often takes a few months for a pattern in the stock markets to become clear and only then do fund managers adjust their positioning to avoid getting whip sawed, so we will know more over the coming weeks but in the meantime, it is very difficult to read. I hope this explains the slightly confusing pattern in the markets of late, however as usual please do not hesitate to call or message me if you would like more information.
We are looking forward to catching up with you all in the forthcoming IC meetings.
Kind regards,
Mark Harries – Chief Investment Officer
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