Rebalance pre-Easter 2022

25th March 2022 – Patrick McIntosh – Chartered Financial Planner

Our Investment Committee continues to meet regularly in these very troubled times, as we did at the beginning of the pandemic.

The fog of war continues, the outcomes are unknown and the challenges to humanity are enormous. This is not one man’s war as suggested by the media.  Trump and Putin are remarkably similar bedfellows.  As with America where 50% of the voting population voted for Trump in the last election, so too possibly 50% of the Russian population genuinely believe in the actions that they are taking and will not be dissuaded otherwise.  I have first-hand experience of this, having cycled from one end of Russia to the other only two years ago!

Notwithstanding the tragic effects of the conflict, we continue to be relatively optimistic in the sense that it should not become a wider global event.  Later this year we expect there to be some form of resolution which will stabilise markets allowing us all to envisage a new world order. What we can be certain about is that, as with the pandemic, the world has rapidly moved on and we will not be going back to the past especially in terms of reliance on cheap energy and cheap labour (despite the move by P&O this week which will bring further into focus how we stop these actions happening in the future).

In the very near term those unloved assets orientated around old polluting industries have shown significant improvement in share value and this has caught many investment advisers on the wrong foot.  

In the case of your funds which KMG moved earlier this month, a portion of our growth-orientated portfolio was moved back to income generating shares (commonly known as “value shares”) to take advantage of reasonable dividends available from those many companies that had been unloved in the last few years – especially in the light of exposure to inflationary items such as commodities and food chains.

Like most people, we did not expect the stupidity of the Russian actions to take place, however we are relatively comfortable with the performance that we have seen in the investment strategy and the resilience of the funds.  The thematic themes which we still think are likely to be the most profitable way of investing for the future we feel will still deliver longer term, in particular in areas of sustainability and decarbonisation if for no other reason than the Russians have forced our hand to realise that we simply cannot be reliant upon them or their source of energy, as is shown today with the EU striking a deal with the US.

Central banks remain in a very challenged position.  On the one hand they see inflation rearing its ugly head and are challenged to head off an explosion of wage rises and prices spiralling out of control.  On the other hand, they appreciate that to put up interest rates at a time when everybody is suffering from a massive increase in the cost of living could well be counterproductive if it means that a large part of the economy grinds to a halt for lack of spending power.

We do not expect interest rates to rise above 3% in the near term, and this means that cash is likely to be a very unattractive investment simply because inflation is likely to be in the region of 5-7% in the foreseeable future, thus leading to negative cash returns. We also worry about fixed interest government and corporate bonds, both of which are likely to lose value even with modest interest rate rises.  If the war gets out of hand and the global economy grinds to a halt, then interest rates may rise.  At the moment this does not seem to be a likely outcome.

We do expect capital spending to increase much as we predicted before the war.  As a consequence of the conflict, we now expect any increase in capital spending to be focused on new energy sourcing, on becoming more self-reliant for food and at the same time investing in a very different world of energy-efficient transportation and economic activity.

We are therefore making some modest changes to the portfolio.  We continue to feel that the best way of developing a strategy is to gently make changes in the right direction.  In this way we maintain moderation and manage volatility whilst seeking greater profitability in a reasonable period when the world returns to the thematic themes which we have been developing during the last few years.  These themes are even more relevant now than they were 5 weeks ago.  We are always conscious that a very good fund manager gets about 40% of their decisions right, 40% drift sideways and 20% are wrong.  If the conflict is a benchmark of this principle, then the 20% that was wrong five weeks ago has proved to be right five weeks later! 

May I remind you, when considering performance against indices, while we have underperformed in the last three months, if we look back three years, we are showing returns of more than 50% of those of the FTSE100 index, as an example.  It is also important to remember that indices are pure equity.

The modest changes to the portfolio are detailed below and will be actioned next week.

Increasing further exposure to Real Assets

Real assets such as commodities, resources, infrastructure, and real estate typically perform better in a high-inflation environment as commodity/resource prices typically rise alongside goods and services while infrastructure assets often have some sort of inflation-linked leases embedded in them. On that basis we are simply increasing exposure to existing funds including L&G Global Listed Infrastructure, Baring Global Resources and Cohen & Steers Diversified Real Assets. 

Increased exposure to Value Funds

Following the changes earlier this month we are increasing our exposure to Value by adding to two new funds: Dimensional International Value and BNY Mellon Global Income.

Reduced exposure to Fixed Income Funds

As inflation expectations have risen this is typically negative for longer-duration bonds. Thus, we are reducing both our bond and duration exposure and adding to cash which we believe will provide better protection in the near term.  Holding cash will also be beneficial if we see recessional risks rise and, of course, provides us with the opportunity to invest quickly when we see opportunities present themselves.  We are mindful that inflation is not good for cash and retaining true value, but this is to balance the risks of the markets as well as inflation issues.  We will, therefore, add some exposure to global index linked bonds to attempt to mitigate some of the inflationary pressures.

Where changes are made within portfolios, except the VT KMGIM Medium High Fund, there may be some capital gains tax incurred when switching outside a tax-free wrapper.   The fund charges for the portfolios will decrease marginally, except for the Low portfolio, which will increase by 0.01%.  There is no change to the fund fee of the VT KMGIM Medium High fund.

Changes will be made during the week of the 28th March 2022.

We will continue to review the portfolios on a very regular basis and report to you on our thoughts and findings as the crisis unfolds.  We will continue to screen the funds that we buy as best we can to meet all moral obligations, but we must remember that some of the larger energy companies will be needed to move to more sustainable energy supplies as they have the resources and know how to do this.  As the world also moves to distancing itself from countries like Russia and Belarus, so will fund managers and therefore our strategy, but the severing of contracts will all take time.

For now, stay safe and well and enjoy the spring sunshine.  We will continue to update you on our thoughts and actions as matters evolve.