28 March 2022
Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary below is not intended as a recommendation for you to personally buy or sell any of the investments mentioned nor to take any investment action whatsoever.
Since I wrote to you in January, 'growth' oriented stocks have continued to underperform the overall equity market. For example, the Scottish Mortgage investment trust that is perhaps the most popular 'growth' oriented investment strategy in the UK is down 11% since then whilst the global equity market is down only 1%. This has been driven, in part, by interest rates that continue to move higher.
Investors who have performed poorly over the past six months or so have probably been exposed in one or both of the following ways:
I've covered the issues with 'growth' stocks and interest rates previously, particularly in January but also in September 2020. Since January, the likelihood that we are indeed in a new regime of rising interest rates has only increased. The message from central banks has changed materially in recent months; it now appears that their chief aim is to attempt to significantly reduce inflation expectations and the only way they can try to do this is to cause interest rates to rise. This will manifest itself with things like a 0.50% increase in the base interest rate by the US Federal Reserve at its next meeting and, at the same time, an announcement that it will begin to sell a significant amount of the assets it bought during the Covid crisis (which, all else equal, should also push up interest rates further).
Rising interest rates would also continue to mean that bonds and other investments that get hurt by higher interest rates offer poor protection for 'balanced' portfolios. This is the part of portfolios that is supposed to offer robust defensiveness when equity markets turn sour but has, in many instances, failed to do this during the most recent selloff.
One of the fundamental problems is that lots of non-equity investments have benefited from falling interest rates in recent years: government bonds, corporate bonds, real estate, 'infrastructure' and various others. A backward looking portfolio construction process thinks that these are great investments but that may only be true when interest rates are falling. When interest rates go up, such investments, all else equal, decline in value.
In sum, a portfolio of growth stocks and the above non-equity investments - a popular combination due to its many years of outperformance - has performed really quite poorly of late and will very likely continue to do so if interest rates keep climbing.
For our part, in the non-equity parts of clients' portfolios we are very 'underweight' bonds and have stayed away from other investments that tend to go down when interest rates go up. Instead we own 'market neutral' funds and, in some cases, US dollar denominated investments that, in GBP terms, tend to go up in times of stress.
Clients of TindleWealth's 'balanced' strategy lost 7-8% of their portfolio's value at the lowest point so far this year. TindleWealth's 'growth' strategy (which is 80% equities) lost 10-11% at the lowest point. While there will undoubtedly be managers that have performed better, our client portfolios have performed reasonably well during a period of considerable stress. I am optimistic that this bodes well, at least on a relative basis, for the volatility that I think markets will continue to experience over the coming quarters.
It's only fair that I point out where we have performed poorly which is principally within our equities allocation. Our overweight to emerging markets has been a significant drag on performance as the war in Ukraine has hurt returns in emerging markets. Also, our perennial overweight (for UK domiciled clients) to UK domestic equities, e.g. the FTSE 250 companies, has underperformed benchmarks that are quite heavily weighted to the more globally oriented FTSE 100.
I've made repeated references so far to a challenging near term outlook and I do believe that the volatility will continue for a few more quarters. However, such volatility also presents opportunities. For one, equities on the whole are far less expensive relative to their profits than they have been at any time since March 2020. Also, equities should offer decent protection to high inflation as certain companies can, at least to some extent, protect their profits by passing on price increases to their customers. In fact, while equities are volatile they offer far better protection from inflation than bonds and other investments that are perceived to be more defensive. So despite my near term cautiousness, remaining invested - particularly in a manner that is consistent with one's unique risk appetite - will almost certainly be a good move in the long run.
Please get in touch if you would like to discuss any of this in more details.
Scott Tindle, CFA is the Founder & Director of Wealth Management at Tindle Wealth Management.
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