Expert: Altaf Kassam, MD, EMEA head of investment strategy and research Facilitator: Sam Shaw, independent consultant
Headlines:
- Gatekeepers are still largely cautious on UK gilts, and pondering how to dip their toe into longer duration fixed income exposures
- Defensive and quality value plays are sought by investors, and most are willing to play a premium for that exposure
- We won’t go back to ‘the Great Moderation’ – can’t rely on central banks to backstop the market anymore
- The current challenge is trying to balance an inflation “obsession” with worrying about growth
Context:
The group shared a general scepticism over alternatives to equities and bonds for income.
Macro: A growth recession or worse?
For now, bond yields have stabilised & sterling has picked up so it’s unlikely the UK is on course for full-on recession unless something comes from left-field.
Quantitative tightening increases that recession risk; volatility will remain for the foreseeable and there is a belief that quality & defensive sectors will fare better in such volatile times.
Markets are pricing for ever-higher interest rates as the central banks (in developed markets) seem to only really be focusing on controlling inflation right now, which will inevitably have an effect on growth. That said, we’re talking about a slowdown in growth, not shrinking or reversing. Forecasts are still in positive territory.
The so-called ‘Fed pivot’ (which was suggested would be more subtle) might happen in the middle of next year, perhaps Q3. It will take until then for the effects of interest rate hikes today to truly be felt.
There is some good news in that most of inflation was driven by supply side issues, which are easing. Demand is also tailing off. These factors will combine next year, encouraging central banks to take their feet off the pedals, in terms of rate hikes.
USD is hugely overvalued. Recent dollar strength has hurt other economies, especially importers of commodities. We are expecting that carry trade to ease off as the dollar weakens in relative terms. That said, we are all vulnerable to geopolitical shocks, so a general sense of caution was shared by most participants.
Fixed income: the return of long duration?
SSGA doesn’t think we are heading back to the 1970s (with superhigh inflation and rapidly rising rates). There has been a massive repricing in fixed income, with the days of negligible rates finally behind us.
Cash looks like a good strategy in part as it offers some optionality.
The question over duration is when to move out. Delegates can see the opportunity that lies in duration exposure, but given the burn it’s felt to date, are cautious of making the move too early.
Fixed income is their ‘safety first’ element of client portfolios, so acting with caution. Some are making tentative steps into the asset class, but predominantly at the shorter end of the curve in the short term. Sustainable FI has not fared well – adds another constraint.
Some views were shared that the UK still demonstrates too much risk, vis-à-vis the US, and its inflationary dynamics are more complicated. Gilts are still not offering the diversification role they should and there were views it would still take a while to come back.
There was some interest in high yield but exercising caution over valuations and on spreads.
Investors are becoming increasingly in need of some inflation protection, but alternative sources of income – real assets etc – are still really investing in equities or bonds, when you look under the bonnet. No real other options available that can offer diversification and income generation, with a reasonable track record.
Views were split over currency hedging. One view was that all currency ought to be hedged, even when taking a position in Chinese government bonds, because they were not specialist currency traders so it was building in another element of risk. Other views, not so much.
Equity exposures: position defensively in factors and sectors
Seeing much more dispersion in factors. Value continues its rebound. Quality is always relatively expensive but given how prices have moved (especially in the US), it is now looking better value.
There is broad appetite for combing quality and value where possible (which is even more difficult to access in the impact/sustainable space). Most Gatekeepers will pay a premium for reliable factor and sector-based exposure though costs are front and centre of conversations, especially for new clients. For those who favour a factor-driven investing approach, an offering which combines a complimentary quality and value base was welcomed.
Some raised concerns over the validity of factors and how the underlying investments might shift over a timeframe. E.g value means different things. Utilities will behave differently to banks in a recession. Quality is largely comprised of US tech, so difficult to really know what you are investing in.
We heard a discussion of playing factors through sectors: more easily comparable, relevant, stable. One investor said they found factors difficult to map onto a macro framework.
There were mixed views on low volatility. One investor had benefited from a low vol fund, which “bailed them out” this year. Another was concerned over the algorithms used and the inconsistency of performance.
At sector level, healthcare boasts defensive qualities (strong earnings, robust margins, strong free cash flows, holdings not yet extended - but are moving up), while playing long-term demographic trends (aging population etc).
Research frameworks are typically drive by regions rather than sectors, but some global thematic exposure and some tactical calls being made, although some are still using active to do so.
Key takeaways:
- 60/40 may not be dead but is becoming more nuanced
- More bespoke solutions created for DFMs offers their clients better choice and a USP
- Most asset classes should see an uptick next year as economic pain works its way through the system
