The benefit of hindsight
Tara GillespieHead of Global Assets
If you’ve spent much time in the wealth management world, you’ll likely have crossed paths with someone bragging about an investment decision they made that paid off. Despite these decisions often being down to chance, time and time again, they’re used to demonstrate superior investment skill. I met one of these people recently; “I sold all my fixed income last Christmas into cash,” they said. “It was obvious what was about to happen,” they added. Most things seem straightforward in hindsight – let’s see how obvious this really was.
Over 2021, equity markets continued their 12-year rally, supported by the largest monetary stimulus the world had ever seen. In the aftermath of Covid, inflation had begun to creep up from 0.6% in December 2020 to 5.1% by the end of November 20211. Although the narrative around inflation was ‘transient’, the Bank of England had just agreed to a 15bps rise in base rates. The aforementioned investor’s fixed income investment (Global Aggregate Bond) had been broadly flat for the year. This backdrop alone could have made a move from bonds to cash seem attractive. And this attraction is amplified when you factor in a series of events that no one could have predicted: the war in Ukraine turbocharging inflation, accelerating central bank action on interest rates and, more recently, the impact of the recent ‘mini budget’ from the UK government.
So, where do we go from here?If you’re sitting on a 60/40 portfolio (i.e., a rough allocation of 60% in equities and 40% in lower-risk assets) with your 40% in cash, you’re probably feeling pretty pleased with yourself – given sterling and global corporate bonds have sold off significantly year-to-date and are experiencing a bear market. Inflation is rampant (particularly on our side of the pond), and the Bank of England is committed to combating it. With a recession also on the cards (it may already be here by the time you read this), we’re in a market that’s very tricky to navigate.
1CPI Annual Rate. ONS. December 2020 – November 2021.
Is there a good alternative to cash?With bond markets taking a hit this year (from a valuation perspective), you can expect to generate a far more attractive yield from these assets going forwards. The table below shows the yield you can expect to generate across a range of fixed-income assets. With the market pricing in 10-year gilt yields at 4.15% and 10-year treasuries at 3.83% at quarter end, even the highest quality bonds are beginning to look interesting.
There needs to be a balance between yield, credit quality and duration. There’s still some room for upward pressure on rates, making lower-duration, high yield assets potentially more appealing. However, when faced with recessionary concerns, these lower-quality assets bring higher default risk, so balancing this with an investment in higher quality investment grade assets is key.
Gilts
Global Aggregate Bonds
Sterling Investment Grade Corporate Bonds
Global Investment Grade Corporate
Global High Yield
Representative Index
UK Government 30Y Gilt
SPDR® Bloomberg Global Aggregate Bond Index (GBP hedged)
iShares Core Sterling Corporate Bond UCITS ETF in GBP
iShares Global Corporate Bond GBP Hedged UCITS ETF
iShares Global High Yield Corporate Bond GBP Hedged UCITS ETF
Yield
3.83%
3.70%
6.59%
5.32%
8.20%
Duration
-
6.74
6.47
6.16
3.69
Source: MarketWatch, State Street, iShares. Data as at 30th September 2022.
A word on alternativesBeyond the world of fixed income, there are many attractive investment opportunities that have a low correlation to both equity and bond markets. Liquid alternatives offer a low-cost access route for alternative risk premia and alpha sources that provide genuine diversification to traditional investments. We’ve seen these characteristics play out this year, with most equity markets in the red and many liquid alternative funds in positive territory.
Is it now or never? This is a volatile market environment; consequently, the data we’re basing our investment decisions on is stale before it’s even hit the page. In times like these, it’s wise to spread the entry point. This doesn’t mean being too smart around ‘timing the market’ – attempt to do that and things might reverse before they reach the level you were waiting for. But it does mean ‘time diversifying’, so you aren’t overly exposed to market conditions on a single day. This could be over a period of weeks or months, depending on your strategic needs.
No matter what anyone says, between geopolitical uncertainty, unpredictable government policy announcements (and U-turns) and central bank interventions, we just don’t know what markets will do over the next year. All we can do is make good decisions with the information we have today. And on that basis, through a diversified mix of fixed income and alternative investments, we genuinely believe there’s a good alternative to cash. Let’s see if hindsight agrees!