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Three steps to a portfolio health check | Long-term issues affecting investors | Signs of change for Emerging Markets
A turning point for emerging markets equities is approaching as the drivers of recent weakness rapidly dissipate, believes Pendal’s James Syme.
The end of the US rate cycle is starting to come into view and a newly engaged China is beginning the process of restoring growth, says James, who co-manages Pendal Global Emerging markets Opportunities fund.
That leaves it increasingly likely that stronger returns from EM stocks are imminent, he says.
“The two big drivers of the difficult environment in emerging markets in the last 21 months all seem to be improving,” says James.
“Right now, you don’t want to be too underweight EM and you don’t want to be too underweight China.”
Strategic asset allocation is about setting aside the day-to-day noise and thinking about the long term.
For example, three long-term issues that stand out to our multi-asset team are the build-out of renewable energy infrastructure, persistent higher inflation and geo-political risk.
Weighing up these themes and others has led the team to recently adjust their portfolios.
“We’re increasing our exposure to bonds,” says multi-asset PM Alan Polley. “They’re are offering attractive yields and have material diversification benefits. This will also help defend against a potentially more volatile, long-term outlook.
“We’re also moving some capital into sustainable investment companies. With the secular theme of higher inflation, you want more real assets.
“Net-zero carbon emissions commitments provide a tailwind for renewable energy assets and a hedge to energy inflation.”
A regular portfolio health check is a critical part of successful investing – and doubly so after a volatile 2022.
There are three steps to follow says Alan Polley, a portfolio manager in Pendal’s multi-asset team:
Risk tolerance and long-term goals shouldn’t change after a negative year, says Alan.
“When markets are volatile, your portfolio can stray away from your risk tolerance, and potentially at the wrong time.
“Buying cheaper asset classes at lower prices the ones that have sold off and are giving you the pain – should add to your returns over time.”
This year reminded investors of a few things, says Pendal’s multi-asset chief Michael Blayney.
“The first one is that volatility in financial markets is a normal thing,” says Michael in our latest fast podcast.
“It can obviously cause short-term pain, but it also creates opportunities for investors willing to take a long-term view when value arises.
“Secondly, people had assumed bonds and equities would always move in opposite directions with that negative correlation we’ve seen over the last decade or two.
“But the reality is that correlations and diversification benefits of various asset classes do vary over time.”
Beyond bonds and equities, Michael recommends “meaningful allocations to alternative assets.
“Some of the exposures there – particularly those that have given us a bit more energy-price exposure or some commodity-linked exposures – have actually performed quite well in the last year.”
War, floods and China policy changes pushed this year’s COP27 climate change conference off the front pages.
But there was one thing investors should note, says Pendal Credit ESG analyst Murray Ackman.
COP27’s main achievement was an agreement that bigger polluting countries would compensate developing countries for the effects of climate change.
Some are now calling for this same logic to be applied to companies.
“This has obvious implications for investors,” says Murray.
“If the logic is high emitters bear responsibility for mitigating the impacts of climate change, this adds credit risk.”
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China’s big policies moves | Why the 70:30 portfolio is back | Bonds to watch out for | Inflation outlook
Despite a volatile 2022, the long-term outlook for investment markets is more positive than it has been since 2014, says Alan Polley, a portfolio manager with Pendal’s multi-asset team.
The team has just completed its annual strategic asset-allocation process, looking at long-term trends and expected returns across asset classes.
Key to the forecast is improved returns for bonds. US 10-year treasury yields have risen almost 3 percentage points in 12 months, offering attractive yields for the first time since the GFC.
Bonds can once again play a defensive role in a traditional balanced portfolio — often called a 70:30 portfolio for its split between equities and fixed income — as well provide a reasonable level income.
This is even more important for conservative portfolios, which tend to have a higher allocation to bonds.
“Over the last five years or so there’s been commentary declaring the death of the 70:30 portfolio.
“Not only was it never dead, but now it’s definitely back and in a much stronger position than it has been for quite some time.”
Last week US inflation rose at a slower-than-expected rate, leading to a surge in stocks.
Are sunnier days ahead? Or will this month’s data join earlier false dawns such as July?
“Although not entirely unexpected, lower inflation will continue to provide encouragement to markets that the Fed can slow the pace of hikes (likely 0.5 percentage points in December),” says our head of government bonds Tim Hext.
“Investors should view any decent rallies as an opportunity to de-risk portfolios for the challenges ahead.”
The super-high inflation battle of 2022 may be won. But the outcome of the war is still uncertain, says Tim.
Getting from 9% to 4% next year will be “the easy part”, he says. Commodity shocks from Russia and tight labour markets will likely see inflation get sticky around 4%.
“Unless we tip into a steep recession the US Fed will remain wary about calling victory on inflation soon.”
IT’S easy to forget that newspaper headlines are designed to do only one thing: sell newspapers.
If anyone needed a reminder to look past the headlines, they need only look to the UK, says Pendal’s Clive Beagles.
The headlines have focused on the UK’s political instability, energy market disruption and the prospect of a recession.
Yet UK shares are the best-performing developed market in the world this year — and still offer strong value, healthy dividends and the prospect of growth, says Clive, a senior fund manager at Pendal’s UK-based asset manager J O Hambro.
Consider this: the 600-company FTSE All-Share Index trades at a similar market cap to Apple.
“It’s crackers. One is a two-product company — the other is an extraordinarily diverse index in all sorts of industries. And yet which one have investors got more money in?”
More companies are issuing “sustainability-linked bonds” — debt securities that pay a coupon linked to environmental or social outcomes.
These bonds typically don’t fund a specific project — instead they set overarching goals such as reducing emissions or improving corporate diversity.
If an issuer fails to hit its goal, usually it pays a penalty in the form of a higher coupon.
Sustainability-linked bond issuance hit US$103 billion globally last year — a yearly increase of 803 per cent, according to World Bank research.
But investors should take care that issuers are genuinely making changes and not simply greenwashing, says Pendal Credit ESG analyst Murray Ackman.
“In theory, they are great — but we’re starting to see some things we are not happy about with these structures.”
China stocks surged after Beijing finally made market-friendly policy moves on Covid re-opening and property industry debt.
Is this bottom for Chinese equities?
Investors should broadly see this as a buying opportunity for the best-positioned Chinese companies, says Pendal emerging markets manager James Syme.
“We essentially believe China’s policy choices in the past two years broke its economy and equity market. We may now be seeing the beginning of changes that are needed to fix this.
“We have very significantly reduced our underweight position in China.”
Some sectors remain unattractive though, he cautions. Avoid state-owned banks, private-sector property developers and tech giants with poor corporate governance.
How to read the rally | The signal that will end rate hikes | Lessons from US earnings season
What can investors learn from US earnings as big-tech layoffs continue?
For equities investors, 2023 will be a story of correcting a “misallocation of capital” that occurred during the pandemic, says Pendal’s head of global equities Ashley Pittard.
“You don’t want to be in the Covid winners, you want to be in the Covid losers.
“There has been an over-investment in technology and the cloud and a misallocation away from industrials, supply chain, energy and those sorts of companies.
“You’re now seeing that misallocation of capital unwind.”
As for the big picture, a weaker US quarterly earnings season indicates a recession is likely next year, says Ash.
But there’s evidence US companies are rebuilding supply chains post-Covid, which should soften the impact as capital spending offsets slowing consumer demand.
Pendal’s Paul Wimborne and his colleagues identified a fundamental turning point in EM drivers in late 2020 The team believes conditions are ripe for strong returns in some Latin American…
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