Our investment portfolio selections for Winter/Spring 2022.

EDITION 36 PORTFOLIO SELECTIONS

2021 has been a remarkable year for investment with as much happening that both supports and undermines market confidence. We started 2021 with President Biden Democrats winning the Georgia State Senate run-off election and with-it overall control of the US Congress. President Biden’s show case legislation in the form of the US$3.5tn Build Back Better bill and the US$1.3tn Infrastructure and Clean Energy bill were expected to make swift progress and America launch an unprecedented capital spending programme. This would be a great boost to the recovery but also the beginning of the concern that inflationary pressure would grow.

The 10-year US treasury yields spiked in mid-March, up from 1.4% to 1.74% as a market reaction to the threat of inflation building in the US economy. This spike had a negative impact on our Edition 34 portfolios at the time as we had exposure to longer dated bonds and gilts that were hit by rising yields and the resultant compensatory price falls. Longer dated credit is more impacted by inflation due to their durations. We had also maintained our US tech holdings but had added a new iShares Clean Energy ETF, which had been doing exceptionally well and, in a sector, expected to perform on the back of Biden’s spending and the global shift away from carbon. The clean energy and tech sectors in general are heavily leveraged and therefore at the time, hit by the chances of a US interest rate hike earlier down the track than either wanted or expected. The combination of long dated credit and iShares Clean Energy Fund losses left our portfolios behind the national averages and in need of restructure.

We took action with a mid-term rebalance to reduce exposure to long dated credit as the likelihood of rising inflation would further hit duration and the removal of the iShares Clean Energy ETF as being too volatile a holding and replaced by the Guinness Sustainable Energy Fund and Baillie Gifford Positive Change Fund. Both of these funds have done well and will remain holdings in Edition 36. As of 8th November, these funds had grown 20.95% and 20.39% over the past six months respectively. All our portfolios suffered from being behind the recent national averages through the summer, but due to changes we made in April and then again in July we have recovered and are back ahead over the past 3 months and 6 months.

Markets have over recent months been nervous for a number of reasons. We have seen the impact of global supply chain weakness, spikes in natural gas prices, labour shortages in key areas and high levels of transmission of the Delta Covid impacting upon the workforce. Despite these headwinds, the economic fundamentals are still good, PMI indicators are positive, US earnings season was very successful, interest rates remain very low, The Federal Reserve’s tapering has been well received, vaccination rates in developed countries are high, US new job numbers are healthy and growing and over time supply chains will get fixed and inflationary pressure ease.

Economic growth has certainly slowed from the first half of the year. The authorities in Beijing have tightened in order to cool their overactive economy. The current rate of growth of 4.9% in Q3, which is slower than many analysts had predicted, is expected to prompt a reversal particularly after the blackouts and power outages. US growth has also slowed but with a new 531,000 jobs created in October there is still growing demand to come through.

It has been the bond markets where we have been most nervous as inflation will hurt fixed returns. For this reason, our last Edition 35 holdings were particularly defensive and heavily allocated to short dated and index linked to protect assets from inflation. Our average duration in Edition 35 was 3 years. This strategy certainly worked right through to early November when a shift in sentiment over equity returns also saw an improvement on long dated credit returns.

The new Edition 36 bond allocations are more diversified and less concentrated. We have retained a majority of short dated and index linked but have reintroduced some global corporate bonds and UK gilts to the mix along with some new asset backed securities, some target return bond funds and floating rate bonds as we anticipate interest rate rises in 2022.

It is due to the potential for inflation to become more established within the economy, mainly through wage pressure and supply chain problems that we have added a holding in gold. The BlackRock Gold and General Fund is a play on the demand for gold going forward.

Fund management groups see inflation as increasingly likely to be with us for longer that first expected. However, many feel that the US has hit peak inflation and that the rate of price growth will ease. The UK is yet to hit peak inflation which the BoE expect to be April 2022 and could hit 5%. Due to the massive gas price rises Finch expect UK CPI inflation to hit 4.3% at the end of 2021.

With inflation ahead and interest rate rises to come we want to hold fixed interest holdings that have some protection within. We are therefore holding index linked and floating rate allocations.

Investment returns are influenced by economic circumstances. The value of the future cash flow is sensitive to expectations over interest rates, inflation, growth outlook and central bank policy. Due to the differing tensions within the global economy, it is particularly important to maintain a very diversified portfolio going forward across the asset classes, sectors and regions. This policy of diversification has held us in good stead this year and we expect the same in 2022.

Our allocation to equities remains in line with the portfolio risk profiles however, we have increased our allocation to property funds in Edition 36. Both equities and property do a better job against inflation but not high inflation. Markets that might be hardest hit by high inflation would be the US as they have the richest values. With the US expected to have hit peak inflation this issue seems to be less of a threat. The places to find downside protection from inflation is precious metals, infrastructure, commodities, financial stocks, property and index linked credit all of which are held in our portfolio’s. We have also added three new funds that have a target return objective. The BNY Mellon Real Return Fund, which we have held in the past, the Artemis Target Return Bond and the Royal London Diversified Asset Backed Securities Fund to bring some additional volatility management and diversification to the overall portfolios.

As far as the year ahead is concerned there are some key themes to consider. The tapering of US Federal Reserves quantitative easing programme and the timing of a future US interest rate rise. The development of the US labour market and future wage inflation rates. The success of the Biden Administration in implementing its Build Back Better investment programmes that will create demand within world economies. We will watch with interest how China overcomes the eventual collapse of the Evergrande property company and manage the likely fallout and hit on economic growth.

Business will fix the supply chain inefficiencies, but it will take time and the world will progressively recover from Covid so that we can expect an improving economic environment. The one thing that we cannot underestimate is a policy error that causes markets to react and correct. We are in high value stock market territory particularly in the US so this is always a concern when growth rates slow.

The recent US earnings season has put life into equity markets. It is also quite possible that optimism over the ongoing recovery and correct policy decisions in Washington and Beijing will see markets perform well over the months ahead. All eyes will certainly be on the Fed over the next year.

---

Comments are closed.