At the end of March, with your agreement, we will be rebalancing portfolios in line with your agreed attitude to risk and objectives; we do not plan any major changes of funds or holdings at this point but continue to keep the position under review.

Whilst we do not have any major changes planned at present, we feel that it is important that we convey to you our strategy, the risks we face, potential opportunities and the tools that we use to make our decisions.

Ongoing Monitoring

Every week we get through a lot of information relating to investment markets and funds; our internal weekly diaries where we make notes on key information and market monitoring processes are formalised at the end of every month in the form our of Investment Committee Notes (let us know if you would like us to send a copy).

This encourages debate and discussion about the key issues that drive our investment decisions and provides an excellent audit trail for future critical analysis so that we can see what when right or wrong.

To help us we have built our own database that allows us to look at how strategies would have performed all the way back to 1973; this is important as it encompasses periods of high inflation and interest rates that we have not seen in the last twenty-five years.

By looking at this data we can build up an idea of what to expect from different asset allocations in different conditions, the likely range of returns and worst-case scenarios! These are not perfect, but certainly provide us with some more than reasonable indicators as to likely outcomes.

Based on our tests what we can tell you about our current strategies is that all would have had reasonable returns profile and over periods of five years or more returns are in the main positive.

The returns are less in very low interest and very low inflation environments – as we have seen in recent years – but are generally positive.

Performance would have been positive in both rising and falling interest rates so, although slightly better when inflation and interest rates are on the rise reflecting our current allocation to equities (we would expect equities to perform relatively well in this environment as it is indicative of an expanding economy.

The very best returns tend to come after interest rates and inflation peak; unfortunately, these tend to be preceded by very negative conditions for most asset classes, but particularly equities.

This is reflected in the maximum losses that would have been seen in the high inflation era of the 1970’s when the current allocations could have declined up to 30%; however, we would make the point here that Index Linked Gilts were not at the time in issue and could have made a significant difference to this. The Tech Bubble and Financial Crisis would have seen maximum losses range from 15%-30% depending on risk levels.

Using this information leads us to the conclusion that our biggest risk to future returns is currently inflation; whilst a severe decline in equity markets would be uncomfortable the risk from inflation is far higher and we must do all we can to try and provide protection from it.

CURRENT CONDITIONS & STRATEGIES

The start of 2021 has seen a lot of backwards and forwards for investment markets; a lot of this variation is being driven by sentiment that is in turn driven particularly by news on vaccine roll-out success/failure. Our current strategy is to continue to diversify across asset classes and geographical regions; the following points summarise our views and expands on some of the key ideas and concepts that we have been thinking about.

We considered increasing cash holdings in view of fragile equity markets but with inflation rising the “cost” of holding too much on deposit could increase and the value of capital would be eroded.

Changes in inflation and interest rates are crucial for all asset classes and whilst later we will be looking more closely at commodities for now, we want to show the importance of Copper (or Dr Copper as it is known) when thinking about the direction of interest rates and inflation. As an industrial metal with many uses a high demand for Copper is seen as a sign of economic expansion when interest rates and inflation will start to rise – particularly if the economy starts to overheat.

The traditional method to combat inflation is for a Central Bank to raise interest rates; whilst Government spending requirements remain significant this is something they will be seeking to avoid. However, the Copper/Gold ratio is telling us something different and the yields on US and UK Benchmark Government Debt has been moving up. We would expect the Central Banks to step in and force yields down in the near term even if this is at the expense of rising inflation.

With the prospect of rising inflation and interest rates in the short term we feel that Index Linked Government Debt in both the US and UK is preferable.

The US Energy & Technology Sector

We are focusing on some key areas in equities that offer value; in particular, the out of favour energy & resources has performed extremely well in recent months. From a geographical perspective the UK and Japanese equity markets continue to offer some value as many of the constituents of their stock market include the “old economy” of Resources and Financials that have underperformed in comparison to the Technology heavy US Stock Market where firms such as Amazon and Zoom have benefited tremendously from their popularity in the pandemic.

It is slightly different in the UK as the FTSE-100 has less Tech firms but the underperformance of some of the big energy firms has been significant. Whilst they may currently be viewed as dinosaurs as ESG (Environmental, Social and Governance) investing takes centre stage, the fact is that fossil fuel extraction and mining will be with us for many years to come. Many of the raw materials for electric cars for example need to be mined and firms such as Royal Dutch Shell are also transitioning to net carbon zero.

Our recovery and return to normal

As Society starts to recover and return to normal, we could also see a lot of pent-up consumer demand as individuals use the capital that they have built up during lockdown periods. This would prove particularly positive for consumer-focused firms and is part of the reason that we hold Finsbury Growth & Income Investment Trust which includes holdings such Diageo, Unilever, Burberry, and Heineken – all firms that we hope will do well as the pandemic (hopefully) becomes part of history.

Over the last twelve to eighteen months our recommendation to hold the Hedge Fund Pershing Square Investment Trust has yielded spectacular results of close to a 100% return. When selecting this holding our thesis was simple – it was extremely cheap relative to history after a particularly poor period of performance and if it were to return to normal then the prospect of some serious capital gains existed.

This has proved to be the case and we must now consider whether we should sell this investment now our objective has been achieved; a lot will depend on whether we can find something that offers a similar “deep value” alternative that could provide similar results in the future.

There continues to be considerable interest in commodities for several reasons although the debate is split as to whether this will be the start of a “super-cycle” or more of a temporary bounce caused by Government spending on infrastructure as they continue their efforts to stimulate economies.

It could also be that specific commodities benefit from long term themes such as the transition to electric vehicles which requires significant amounts of Copper and Nickel. One thing we do know for certain is that commodities are at very low levels relative to other assets, and this could well pique the interest of investors which would build momentum and drive prices higher.

After strong returns during the early stages of the panic Gold has lost its way a little; this could be the result of a combination of factors including profit taking, rising real interest rates, and improving sentiment. In the short term this has led to weakness but in the long-term conditions appear primed for better things.

Interest rates have been rising but inflation is now increasing more rapidly, this means that “real interest rates” (interest rate – rate of inflation) are declining. If we see the US Federal Reserve act to stop rising interest rates this could also have a negative impact on the price of the Dollar which is positive for Gold – higher relative interest rates in a country attract inflows of capital that leads to a stronger currency and vice versa. The spending stimulus in the US is also resulting in widening of the Fiscal Deficit (Government spending exceeds revenues) that is negative for the Dollar and would suggest the currency could be set to decline further)

final thoughts

Whilst we feel portfolios are well prepared and well diversified, we can never be full insulated from potential declines, particularly in a market where sentiment appears to be the key driver. There will be plenty of time in the coming years when we will be better rewarded for taking on risk and investing more aggressively; for now, we continue to recommend looking for consistency and pockets of value in areas or sectors that have underperformed.

Financial Planning Wales Ltd is Authorised and Regulated by the Financial Services Authority. We may record or monitor phone calls for training and quality purposes. The details and material published in this article should not be considered as advice and has been prepared for informational purposes only without regard to your individual investment objectives, financial situation or means