Quarterly Portfolio Update – Q1 2020

And just like that, another decade has been and gone. And who’d have thunk that 2019 would prove to be one of the best years of the decade for investors?

It’s perhaps easy to forget the overwhelmingly popular view of market commentators that, following the downturn in Q4 2018, 2019 would carry on in the same vein and be a bad year for investors. And indeed, the first few weeks of the year we saw markets continue to be spooked. But this was short lived; markets then proceeded to rally throughout the rest of the year.

There were several interesting themes that defined the year for investors. Nothing was perhaps more prevalent than the Woodford Investment Management debacle (for which we wrote a blog about; this can be found on our website). For us, the key point to understand for investors is “Investment will always carry some risk”. At the end of the day, this is why we, as investors, are compensated by generating returns in excess of, for example, cash. As a committee, this is one of the many risks that we constantly review.

This wouldn’t be the last time we’d hear about liquidity risks in 2019. We saw this risk flare in December 2019 in the UK commercial property sector (an area we have had no exposure to since October 2018), with M&G suspending withdrawals from its flagship Property Portfolio fund.

We have seen the FCA wade in on this point, issuing an ‘Effective Liquidity Management’ letter for Fund Managers to offer guidance on the matter. Clearly, our view differs from others in this regard. If you are investing in certain assets (which inherently come with certain risks), investors cannot expect to be able to pick and choose which of these built-in risks you want. We are constantly reviewing liquidity risk, along with other investment risks, but we know its one of the several investment risks that are extremely difficult to avoid. For a market to function efficiently, there has to be a buyer for someone wishing to sell their goods; if there are insufficient buyers to match the sellers then bang, liquidity risks occur.

Of course, you wouldn’t expect liquidity risk from a UK Equity fund manager (the reasons this occurred was more due to the unquoted stuff chock-full in Mr Woodford’s portfolio), but it is not beyond the realms of possibility that liquidity risk can occur in even the most heavily traded markets.

On a domestic note, Brexit once again dominated headlines; with the planned divorce from the EU leading to a Prime Ministerial resignation, a Tory leadership challenge and eventually a General Election. In the lead up to the election, our portfolios were positioned on an ‘all-weather’ basis, i.e. to perform well regardless of the result. In the first few days following the Tory majority, we saw sterling and domesticated UK shares rally hard (perhaps due to their being clearer direction with regards to Brexit). However, markets are fickle things; within a few days these gains begun unwinding as, although the 31st January deadline looked more certain, the longer term effect of Brexit is still largely unknown.

In terms of portfolio positioning, we made some changes to the asset allocation (as detailed on page 18), to slightly increase the equity risk in the portfolios, as we feel there are fewer political headwinds this year, but still maintain a diversified approach with an element of cautiousness.


with Steve Williams

We’re increasingly optimistic for the prospects of both the UK economy and the domestic stock market. If Blighty and her fleet of enterprises can maintain forward momentum, however slow, through the turmoil of 2019, she can certainly do so in the calmer seas of 2020.

There has been a dramatic shift in the outlook for interest rates over the last few days. A week ago, prices in the futures market reflected a 10 percent chance of a 25 basis point cut when the Monetary Policy Committee (MPC) meets at the end of the month. A few days later that probability had rocketed toward 70%. Two trends facilitated that increase.

The first came in the form of a series of comments from members of the MPC suggesting that they were ready to vote for a reduction should incoming economic data deteriorate. There’s nothing particularly newsworthy in that regard, that’s pretty much what you’d expect – especially from those members (Michael Saunders and Jonathan Haskell) that had already voted to cut rates at the November and December meetings. But the market was alerted by similarly dovish comments from two more policymakers (Gertjan Vlieghe and Silvana Tenreyo), bringing those we know to be inching toward a cut to a total of four of the nine ratesetters.

The second trend was represented by the deterioration in economic data. First, we learnt that gross domestic product shrunk by 0.3% during November. That was a surprise to those of us with consensus views expecting a more moderate decline. Then came an equally surprising fall in the pace of inflation during December, wrong-footing the consensus again. Indeed, news of a fall in the headline Consumer Price Index from 1.5% in November to just 1.3% more recently was accompanied by a sharper slowdown in core inflation, this time from 1.7% to just 1.4%. As if that wasn’t bad enough, the Office for National Statistics estimated a fifth consecutive monthly decline in retail sales, marking the longest period of contraction for the sector in a record that stretches back to 1957.

We have some sympathy with those likely to vote for a cut in Bank Rate. The data has been awful and, with rates already low, the Bank will be keen to leverage what little room it has by moving sooner rather than later.

But we’re yet to be convinced that a rate cut is warranted at this stage.

The data being released now pertains to a period of parliamentary paralysis, peak Brexit uncertainty and, ahead of the general election, the potential for another hung parliament and/or a Marxist Chancellor of the Exchequer. Contrast that with a strong (and united) Conservative majority with a clear timetable for Brexit and an inclination to add fiscal stimulus to pre-existing, highly-accommodative monetary policy. There is, at least in our mind, a world of difference.

Still, we think we can count on Haskell and Saunders to vote for a cut, and it seems likely that Vlieghe and Tenreyo will too. Whether we get a fifth member to bring the majority onside is dependent on the data between now and then. It’s going to be a close run thing either way.

Still, we are only talking about the potential for a 25 basis points move. So far as we can tell, market participants are not expecting any parallel bond purchases or other policy measures that might signify a more aggressive shift. In that sense, we are currently in a low inflation, low interest rate environment and that isn’t going to change soon.


Pound Sterling

The last three months saw Sterling rally significantly against a global basket of currencies. The announcement of the General Election, with the strong possibility of (and subsequent) Tory majority victory boosted the currency. However, as mentioned in the market overview, we saw the currency bounce back in the days following the General Election result. At the end of September 2019, £1 bought you just $1.23, the morning after the General Election result, this had shot up ~10% from this figure, to $1.35 per £1.00. And as can be seen in the table on the right, this has fallen back slightly to $1.33. Going forward we do not expect to witness as much volatility in the Sterling market this year as we have done in the past couple of years, but with further Brexit trade negotiations to take place, don’t expect nothing to happen to the pound.


with Scott Mordrick, CFA

Had this article been written on the first day of the New Year, it would have been appropriate to comment that the geopolitical risks that had dominated markets for the large part of the year finally looked like subsiding. There appeared to be breakthroughs made between the US and China with regards to the ongoing trade deals and the ongoing saga of Brexit looked like it would eventually draw to a close. But only several days into the new year and a different geopolitical risk flared up; once again involving Mr Trump’s USA and Iran.

As we mentioned in our Weekly Updates, we did not think that this would lead to a third Gulf war. But it would be foolish to be complacent about a situation like this; it would be easy to see how the situation could hurtle toward deeper conflict.

But perhaps the markets view of this conflict tells you all you need to know. At the end of 2019, you could buy a barrel of Brent Crude (if that’s your thing) for $66. Shortly after the news broke, Brent Crude was trading at $69 per barrel. Following a retaliatory missile attack on Iraqi air basses, it headed to $72. Today a barrel of the black stuff costs $63.

President Trump’s response to the missile attack – as it happens, a relatively tame affair – was to announce an expansion to already expansive US sanctions and to promise that Iran would not be allowed to build a nuclear weapon while he was president.

So, with monetary policy at each of the major central banks likely on hold (or in the aforementioned case of the Bank of England, due for a small cut), geopolitics may well have an oversized effect on asset prices in the first half of this year.

In further negative news, the World Bank estimates that Global GDP growth for 2019 is 2.4%. If this is correct, this will be the lowest global growth for 10 years. Forecasts for this year and the next few years are that the growth rate will increase slightly from 2019 (2.5% in 2020, 2.6% in 2021 & 2.7% in 2022). This isn’t an unreasonable forecast; we’d be inclined to agree with these figures – although if we do see any sort of surprise, we’d expect it to be on the downside as opposed to on the upside.


Economic Overview

In mid December, The Donald become only the third President to be impeached, following Andrew Johnson in 1868 and Bill Clinton in 1998. Neither Johnson nor Clinton were subsequently removed from office. Trump will be no different in that regard.

Impeachment is the first in a two-step process – it is effectively a statement of the charges levelled against the President. A simple majority in the House of Representatives suffices for the first step. Not a single Republican voted to impeach on either of the two charges (or ‘articles’) initiated by House Speaker, Nancy Pelosi. As it happened, three Democrats broke ranks to also vote against article 1 (‘abuse of power’) with two of the three further declining to back article 2 (‘obstruction of Congress’). A two-thirds majority is required in the Senate for a subsequent conviction. Of the 100 senators in seat, 53 are Republican, 45 are Democrats and 2 are independent. Those numbers will not change before the Presidential election later this year. Accordingly, and assuming every Democrat and both independents vote to convict, this Republican President will only be removed from office if 20 or more Republican senators vote for that to come about.

Looking beyond the immediate, we’d be very surprised if the forthcoming trial has any material impact on the outcome of November’s election. Indeed, President Trump’s approval rating has increased this last few weeks. The Gallup poll scores him just 1% lower than his highest recorded rating and a full 6% higher than in mid-October.

We think Trump will still be in post come November this year. And, if the American economy performs in line with expectations, he’ll very likely win a second term.

The most recent analysis, from the Bureau of Economic Analysis, suggests that the US economy grew at something like 2.1% in the 12 months to the end of the third quarter last year. The consensus calls for growth in the region of 2.0% for the full year. We think that’s about right. Indeed, the consensus expectation for the year ahead stands at 2.0% too, in line with estimates from the Federal Reserve. Again, that sounds about right to us too.

But a record 11th consecutive year of growth alongside record low unemployment won’t just be good for Donald Trump’s re-election prospects, it’ll be good for stock investors too.


Economic Overview

The November estimate for unemployment across the eurozone comes in at 7.5%. That’s the same rate as that for October but it is 0.4% lower than it was a year earlier. The good news is that 7.5% is the lowest rate since July 2008 and not that far off a record low of 7.3%.

The bad news is that 7.5% equates to 12.3 million people. But that’s only half the story. Youth unemployment is stuck at 15.6% where it has been for much of the last year. In Greece, Spain and Italy, something like a third of those under 25 are unable to find work.

The longer that continues, particularly in Italy where an underperforming economy has been a feature for almost 20 years, the more volatility in political affairs we can expect.

Another symptom of a broader stagnation is evident in inflation. If the initial estimate is accurate, November saw inflation accelerate from 1.0% to 1.3% across the eurozone. That will please the European Central Bank’s (ECB) new chief, Christine Lagarde. Of course, we are some way off the close-to-but-lower-than 2% target but it’s a step in the right direction after months of steady decline.

The summary section of the European Central Bank’s (ECB) most recent Survey of Professional Forecasters paints a gloomy view. It ‘implies a more pessimistic outlook for inflation, growth and unemployment’.

The consensus sees inflation continue to undershoot the target, rising at just 1.4% in the year ahead. Gross Domestic Product is expected to increase at just 1.0% and unemployment is set to remain at or close to the current rate.

That is why the ECB is not about to change its policy approach any time soon. As it stands, we expect the Governing Council to maintain its current stance for at least the first half of this year.
The implications are that monetary policy will remain supportive of bond prices and, to some extent, equity prices too.


Economic Overview

Japanese economic data is wonderfully volatile. Take the recent estimates for Gross Domestic Product in the third quarter of last year for example. Initially, boffins at the Cabinet Office’s Economic and Social Research Institute guessed that the world’s third largest economy had expanded at an annualised rate of 0.2%. In the last few weeks, revisions to that data revealed a 1.8% increase instead. That’s some jump.

Unfortunately, the fourth quarter is likely to see even the higher, revised Q3 figure reversed. The effects of this quarter’s increased sales tax – from 8% to 10% and postponed several times previously for fear of the negative impact on consumption – will likely see a sizable contraction.

That is one of the reasons why Prime Minister Shinzo Abe has announced a ¥13.2 trillion (£93 billion) stimulus package which, over the course of 15 months, will help to rebuild following Typhoon Hagibis but will also pay for upgraded infrastructure and investment in new technologies.
That is what the Bank of Japan calls active spending. For its part, the Bank of Japan will maintain its present highly accommodative stance with a negative policy rate of interest and an aggressive asset purchase programme.

The International Monetary Fund (IMF) expects the Japanese economy to expand at something like 0.7% in 2020, down from 1.0% in 2019. That sounds about right to us, though it is lower than the Bank of Japan’s forecast for growth in the region of 0.9%.

The Bank of Japan are reasonably convinced that domestic demand ‘is likely to follow an uptrend, with a virtuous cycle from income to spending being maintained in both the corporate and household sectors’ owing to loose monetary policy and increased government spending. Whether the Bank of Japan or the IMF are closest in their estimates will depend largely on outlook for the global economy, such is the extent to which Japanese fortunes are subject to international trade.


Economic Overview

China’s rate of annual economic expansion has halved over the last decade or so. In 2010, the Asian giant registered an increase in gross domestic product of 12.0%. The estimate for the same in 2019 will come in at 6.0%, give or take a 0.1% here or there. That marks it out as the slowest pace of increase since 1992.

We expect the Chinese economy to sustain a slowing rate of expansion for the foreseeable future. In the immediate term, the Chinese economy will slow to something like 5.9% in 2020 and 5.8% in 2021. And that is no bad thing, particularly if, as we expect, employment rates remain strong and wages sustain an improving trend.

What we are forecasting is symptomatic of a structural slowdown in Chinese economic expansion, representing more diversified sources of growth and a more balanced economy.

China cannot sustain sky-high rates of growth without risking a collapse. Much of the growth we have seen in the last two decades – and particularly in the decade since the global financial crisis in 2008 – has been accomplished on the back of an extraordinary increase in debt, a great deal of which will prove unproductive, unprofitable and unsustainable. The transition to a more sustainable model of growth will mandate slower, and less volatile, rates of growth.

In the short term, returns from equity investment in China will be underpinned by some, albeit limited, progress in Sino-US trade negotiations – including a ‘Phase One’ agreement and accompanying pause on additional tariff increases.
In the medium term, though, the markets will likely remain sensitive to the progress – or lack thereof – on the long list of disputes between China and the US, EU, Japan and South Korea.

Having said all of that, we remain cautious with regard to the longer-term prospects for China.

The Financial Times’ Chief Foreign Affairs Commentator, Gideon Rachman, brilliantly articulates the kind of concerns we are fostering. In a recent opinion piece entitled ‘How I became a China sceptic’ he notes that ‘under Mr Xi, term limits for the presidency have been abolished and “Xi Jinping thought” has been written into the Chinese constitution’. In what is fast becoming a personality cult, Rachman observes that ‘party members, students and state employees are forced to study the leader’s thoughts on a regular basis and that ‘billboards quoting Mr Xi’s wisdom overlook city streets…. there are even posters of Mr Xi with rays of light emerging from his head’. The broader context is this…

‘…the Xi era is looking increasingly like one-man rule, rather than one-party rule. And it is hard to think of many places — from Ceausescu’s Romania to Stalin’s Russia — where that has worked out well. (Mr Xi, incidentally, would not resent comparisons to Stalin — on the contrary, he has urged his followers to continue to learn from the teachings of Stalin and Lenin, as well as Mao.)’

As a consequence, we are not shunning Chinese investment. But our position is a guarded one.


Economic Overview

2019 was a year of fading growth across the emerging and developing market economies. From growth in the region of 6.8%, 2.3%, 2.1% and 0.8% during 2018, India, Russia, Mexico and South Africa all appear to have slowed to something like 4.8%, 1.1%, 0.0% and 0.4% respectively.

The International Monetary Fund’s aggregate estimate for the region was 4.5% in 2018 and is estimated to be 3.7% for last year.

Looking ahead though, it seems likely to us that the tentative signs of stabilisation apparent in the final quarter of last year, underpinned by interest rate cuts in the US and a fiscal boost in China and one or two other Asian nations, will broaden out to sustain confidence as what looks like temporary impediments work through the system. Indeed, we are already seeing an arrest in a hitherto sharp deterioration in business sentiment with improving Purchasing Managers’ survey results, even if they are signalling modest rates of expansion at present.

We’re a little more optimistic about the prospects for the emerging market nations this year compared with last year. That has been reflected in a steady increase, from underweight to neutral, in our exposure to emerging market stocks. Last year, returns from all but the Russian market lagged those from the developed market by a considerable margin. We expect any potential for underperformance to be diminished in the year ahead.


UK Property Market

The Nationwide House Price Index
(HPI) revealed that annual UK house price growth for 2019 came in at 1.4%. This was the first time the annual house price growth rate had been above 1% for 12 months.

Robert Gardner, Nationwide’s Chief Economist notes:

“Indicators of UK economic activity were fairly volatile for much of 2019, but the underlying pace of growth appeared to slow through the year as a result of weaker global growth and an intensification of Brexit uncertainty.”

“The underlying pace of housing market activity remained broadly stable, with the number of mortgages approved for house purchase continuing within the fairly narrow range prevailing over the past two years. Healthy labour market conditions and low borrowing costs appear to have offset the drag from the uncertain economic outlook.”

“Looking ahead, economic developments will remain the key driver of housing market trends and house prices. Much will continue to depend on how quickly uncertainty about the UK’s future trading relationships lifts as well as the outlook for global growth.”

“Overall, we expect the economy to continue to expand at a modest pace in 2020, with house prices remaining broadly flat over the next twelve months.”

Meanwhile, in the commercial sector:

“The Q3 2019 RICS UK Commercial Property Market Survey results point to a deterioration in sentiment over the period, with 62% of respondents now sensing the market is in the downturn phase of the property cycle. That said, notwithstanding the structural challenges across the retail sector, many contributors feel the Brexit impasse has become increasingly detrimental to market activity. As such, anecdotal evidence suggests a resolution to the uncertainty could potentially release some pent up demand further ahead…

This (figure of 62%) is up from 53% in the previous quarter and is the highest proportion sensing the market to be turning down since this series was introduced in 2015. Furthermore, beneath the national level, a majority of contributors are taking this view across all of the 12 UK regions/countries covered.”


with Scott Mordrick, CFA

With the exception of MPM000, all of our portfolios outperformed their respective benchmarks over the last three months of 2019. However, the more cautious portfolios posted negative returns over the period, whilst the more equity heavy portfolios made gains, mainly due to the negative performance of bonds over the quarter.

Positive Contributors
The key contributors to performance over the quarter were:

  1. Our shorter duration positions for bonds. Bonds lost money during the quarter, so having shorter duration positions (i.e. owning more bonds with fewer years to maturity than the market), which are less sensitive to price movements than longer duration bonds.
  2. The performance of our UK equity funds, the majority of which had a very strong last three months of the year.
  3. Our Disfavour view on Property, which had another negative quarter (when most other growth assets made money over the period).

Negative Contributors
There negative contributors to performance over the quarter were:

  1. Our allocation to Index Linked Gilts, despite having a Less Keen view on the asset class, fell badly during the month. This was primarily due to Sterling strengthening on the back of the General Election result. The position was held (alongside positions which benefited from a Tory Majority result), as part of a balanced approach, to protect the portfolios from whatever the result of the General Election.
  2. Our Favour position to Overseas Bonds, which not only saw the price fall in their domestic currency, but also suffered (for UK investors) due to the strengthening of Sterling over the period. The same to some extent can be said about overseas equities, which although made money for sterling investors, the amount of growth was hampered by this currency swing.
  3. Our allocation to physical Gold, which lost money during the last quarter.

Portfolio Changes

The committee made no changes in the last three months of 2019. However, at the January 2020 Investment Committee Meeting, the committee agreed to and implemented the following changes:

  1. Retained the same allocation to UK Equity, but changed the weightings to focus more on Mid and Small Cap. This was done by removing Evenlode Income and Franklin UK Mid Cap, adding Castlebay UK Equity and increasing the allocation to Miton UK Value Opportunities and River & Mercantile UK Equity Smaller Companies. The committee also added the Aurora Investment Trust for portfolios MPM060 and higher to diversify the UK Value equity weighting.
  2. Increased the allocation to Emerging Market Equities from Less Keen to Neutral by slightly reducing the allocation to US Equity and Europe Equity, but still retaining their Like, and also reduced the allocation to Targeted Return/Volatility, but retained the Less Keen view.In August, the committee agreed to increase the duration to Gilts, by reducing the allocation to Short Dated Gilts and increase the exposure to Medium Dated and Long Dated Gilts.
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