HUB EXCLUSIVES PANEL DISCUSSION 2022 - THE YEAR AHEAD: THIS TIME IT'S DIFFERENT
Panel discussion, hosted by Cherry Reynard, with:
Ellie Clapton – Portfolio Specialist, Multi Asset, Ninety One
Eva Sun-Wai – Fund Manager, Bond Strategy, M&G Investments
For the past decade, there has really only been one trade in town – the long duration trade. The vogue for reliable long-term cash flows at a time of low interest rates has seen technology shares rise at the same time as long-dated bonds. For investors that have got it right, it has been an easy way to grow wealth. However, that may be all about to change.
The first risk with this trade today is that valuations have become vastly stretched. There has been a small change in fortunes for the technology sector and long-dated bonds since the start of the year, but by all measures, technology multiples are still high and developed market bond yields are still near all-time lows.
The environment has also changed. Across the world, central banks are tightening monetary policy, raising rates and halting asset purchase programmes. Inflation is now the key risk facing investors in the year ahead. This changes the outlook for all asset classes.
The bond market is perhaps the most complex to navigate in this environment. Eva Sun-Wai, lead manager on the M&G Global Government Bond strategy and deputy manager on the M&G Global Macro Bond strategy, says: “We have seen a small sell-off in high yield valuations, particularly at an index level, which provides a good entry point. An exciting area is high yield floating rate notes, where the coupon is linked to interest rates.”
While inflation-linked bonds would seem like a natural hiding place, they have already had a lot of attention, says Sun-Wai, and high inflation expectations are now baked into breakeven rates. “Having said that, they can provide good insurance in a portfolio from increases in inflation.”
Investment grade is perhaps the toughest area to find value, she says. Spreads are unforgiving, central banks are withdrawing from the market and there has been significant issuance as companies scramble to lock in low borrowing. “We are focusing on solid investment grade names with good fundamentals and good diversification purposes, while also looking at more idiosyncratic opportunities in high yield or emerging market debt. There are pockets of value there.” Default rates are likely to remain low.
Equities are also changing direction. Ellie Clapton, portfolio specialist on the multi-asset team at Ninety-One, says risk assets made exceptional gains in 2021, but those gains were driven either by growth stocks benefiting from low discount rates or value stocks that benefited from the reopening of economies. She adds: “That narrowness saw other areas, such as resilient dividend paying equities materially underperform. Even though a number of regions reached all time highs and headline indices have become quite expensive, there are pockets of value to be found. In our view, resilient income stocks backed by strong cash flows are an attractive opportunity relative to broader markets.”
Sun-Wai is finding plenty of opportunities within currencies. “It’s an area of our portfolio where we’re very active. We ended 2021 with the Dollar on a very strong note. Markets had expected that to continue, but it looks like a lot of that strength was front-loaded in Q4 and now markets are expecting policy normalisation elsewhere. Also, on a valuation basis, the dollar looks quite expensive. The yen has seen some strength, having been weak last year because it is a significant commodity importer.”
The Euro has been pretty weak versus sterling and the dollar, driven by the ECB’s dovish stance. It continues to push back against hikes in 2022. They’ve been projecting a modest undershoot of inflation. The Euro is quite cheap and is starting to look more attractive, but it’s hard for markets to fight real yield differentials. That keeps the Euro reasonably range-bound.”
The end of the long duration trade also argues for reassessing diversification strategies within a portfolio. Clapton says listed infrastructure can play a role. It pays an attractive yield and can be negatively correlated to equities, though investors need to be careful on liquidity. The multi-asset team are also seeing specific opportunities within Reits, but with a focus on structurally supported sectors such as tower operators, logistics operators and data centres.
The strategies that have served investors well over the past decade are unlikely to be the ones that see them through an environment of rising inflation and changing monetary policy. Opportunities are likely to be idiosyncratic and valuation-dependent. Flexible mandates and skilled fund management should serve investors well.
