Investment Market Commentary – April 2021
As promised, here is our Quarterly Investment Commentary which provides an insight into our thoughts, and those of our fellow investment strategists, regarding the outlook for the markets. As it’s a quarterly report so I suggest you put your feet up and settle down for a while!
This will be a distilled version of the one sent three months ago because last week I covered off the rotation from growth stocks into value stocks. I have also written recently about the themes we favour. I will spend a disproportionate amount of time focusing on infrastructure for this Commentary because it is this asset class which has seen a sharp pullback in valuations, although it is now recovering some of the lost ground.
We speak to our investment partners on an ongoing basis but at the end of every quarter we have a scheduled 1-hourcall with each of them to discuss what has happened, the current dynamics and the outlook moving forward. Just a reminder, our investment partners are:
The last quarter
In brief, this is what happened:
- The pound strengthened against the dollar which hurt the global exposure of our portfolios
- The successful vaccination programme here in the UK boosted the outlook for the UK economy which in turn boosted UK share prices
- The bond markets sold off with yields rising. Fears over inflation, as a result of the huge amount of stimulus, hit both equities and bond prices. Bonds don’t like rising inflation and equities were hit also due to concerns over an overheating of the economy and rising interest rates, particularly in the US
- Growth stocks like technology suffered, and we saw a rotation into value stocks which have lagged other sectors of the economy
- The storm freeze in Texas adversely impacted both the infrastructure and renewable energy sectors
- As the quarter came to an end there were signs growth stocks were staging a recovery which has continued through the first half of April
- Some US equity indices have now recovered and recently posted record highs
If you had been able to go away and not listen to any news flow for three months, you would now be thinking that nothing had really happened… often the way with investment markets.
Growth or value?
I covered this in my Commentary last time but, frankly, a mixture of the two is the key. Read the last update if you missed it by clicking here.
How important is geography?
When it comes to investing, here at Blue Sky we are more thematically focused than geographically focused. On saying this, it will be interesting to see how countries respond to their vaccination programmes with their relative success being a likely boost to domestic stock markets. We may see a short-term rotation by global investors into specific countries, but we are not going to chase the variances from region to region.
However, geography does play a part (it would have to as I am an ex-geography teacher) in our portfolios. We like the UK for small and mid-cap companies. Europe for larger caps and the Far East for growth stocks.
Sanjay at LGT Vestra reinforced previous comments that China is moving its economy away from an outsourcing country to a consumer orientated country. By 2025, China expects its consumers to spend as much as the US consumer.
We should also not underestimate the trading pact in the Pacific. A symbiotic relationship as China transitions its outsourcing to countries like Vietnam and Indonesia. Asia, when included with Japan, now accounts for a 20% weighting of the world’s stock markets.
Francis Chua from Legal and General Investment Management (LGIM) spoke about government bonds acting as ballast across portfolios, but they have moved away from developed bonds and have rotated into Australia, New Zealand and Chinese bonds in anticipation of stronger returns.
Infrastructure… what is all the fuss about?
I have spoken previously about how the UK committed to a programme of austerity after the financial crisis and how the average person became worse off in relative terms. In the US, where the impact of the crisis was arguably felt the most, with house prices tumbling by 85% in the likes of California and Florida, their only choice was to stimulate the economy. Austerity would have been akin to the final nail in the coffin. Imagine what might have happened here in the UK if we had chosen the path of stimulus instead!
After the deepest recession for 300 years or so, we are seeing a unilateral commitment to stimulus, particularly through infrastructure spending.
Last week I spoke about the trillions of dollars being aligned to infrastructure projects. Infrastructure examples being transportation systems, communication networks, sewage, water and electric systems. These systems tend to be capital intensive and high-cost investments and are vital to a country’s economic development and prosperity.
Why we have used Infrastructure funds
We began using Infrastructure funds within our internally managed Sapphire portfolios in 2019 because we were seeking a strong degree of predictability in terms of future performance. Of course, much of the predictability we were after ‘flew out of the window’ in 2020 with the pandemic!
Previously, we had relied on UK commercial property to deliver a steady income stream and steady growth within our portfolios. It also provided diversity because our core portfolios with LGT Vestra didn’t hold any such assets. However, with the uncertainty around the UK economy, particularly with Brexit, the changing nature of the high street and concerns about liquidity (accessing the capital) we were seeking an alternative asset class, one however that ideally still held physical assets.
Infrastructure, we believed, was the answer and we soon chose Foresight as one of our investment partners. They had been working in this space for many years and had proved adept and nimble whilst demonstrating a significant research capability.
Ironically, we were after a ‘steady eddy’ and really liked Infrastructure funds because they typically hold companies with strong balance sheets, predictable earnings and a strong degree of inflation protection. However, the demand for energy ‘fell off a cliff’ and many infrastructure companies experienced a collapse in valuations in line with the major market indices and, in some cases, by significantly more. The recovery in prices was nearly as dramatic especially concerning global stocks which then surged as energy consumptions increased.
Recent performance of the Foresight Infrastructure funds
The positive news about Infrastructure is at odds with the current price of our preferred Infrastructure funds. The Foresight UK Infrastructure fund has just clawed its way back into positive territory for 2021 and the Global Infrastructure price is still below the break-even mark for the year to date. Stepping back and looking at the performance of the latter over the rolling year from 16th April 2020, then we are looking at a return of over 30% (FE Analytics).
The good news is that the funds are undergoing a recovery with the Foresight UK fund posting a return of just over 3% since the 7th March 2021 and the Global fund over 5% in the same period (FE Analytics).
At our review, LGT Vestra reinforced they like Infrastructure and are adding to their positions.
Infrastructure… the short-term pain and long-term gain!
Is this the case or has all the good news been in the price? We have spoken extensively to Foresight and they are very confident over the medium to long-term about this sector. Furthermore, they are very experienced in the infrastructure space and undertake extensive research. The performance of the Global Real Infrastructure fund since its launch on the 3rd June 2019, compares favourably to its peers.
These are the main points from our discussions:
The big picture
- The wobble in bond markets were a big contributor to some of the underperformance
- The strength of the pound worked against the global fund
- There was a combination of profit taking and technical selling across the market
- Large Canadian clean energy Exchange Traded fund moved allocations away from some assets
- Positive news came out of the US in terms of broad economic stimulus and Infrastructure plans
- Performance has now stabilised and is recovering
Under the bonnet
- Foresight are actively embracing growth sectors including Digital Infrastructure (data consumption, growth and connectivity) which is an exciting growth area
- Global Initial Public Offering (IPO – a new launch) called Cordiant is just one example of an investment into communications via cell towers. Foresight now holds 1% – 2% in the portfolio but looking to add to this position in due course
- There is another UK IPO called D9 Infra (Triple Point) transatlantic deep-sea fibre which are mission critical to communications between the US and UK
- Some of the regression in performance can be attributed to a handful of companies that had performed extremely well over 2020. Primarily, clean energy assets. Undoubtedly there was some profit taking but also the Texas storm freeze cast short-term doubts over the viability of clean energy in replacing fossil fuels
What Foresight are really pleased with
- The general performance, relative to its main peers, is still very good. Foresight funds tend to have a low correlation in performance to its competitors
- The resilience of the income yields due to ‘real’ assets. In stark contrast to other asset classes which have curtailed earnings throughout the pandemic
- The retention of current assets whilst also spotting new opportunities as they arise
- Being able to buy stocks which previously looked over bought at a much lower price
Anything discarded?
There has been an interesting development which reinforces Foresight’s commitment to Sustainability. The Keppel Infra Trust in GRIF decided to buy an oil storage asset in the Philippines. This Trust was one of the best performers in the portfolio, but the Foresight team were extremely concerned by the move into the oil industry and sold their entire position because it didn’t meet their ESG criteria.
A six-month view
- They expect a sharp cyclical recovery in the near term
- There is a potential bump in interest rates due to inflation, but ultimately low rates will continue over the long-term. Governments can’t afford rates to increase due to the levels of debt they currently hold
- Infrastructure generally performs well in a low interest rate environment
- Biden has laid out the terms of the $2 trillion Infrastructure Bill which should provide a favourable tailwind for the funds
- One third of the global fund is positioned in the US and Canada. The pound has weakened after its dramatic surge and a more stable currency bodes well for the performance of global stocks
What to avoid?
- Standalone portfolios of battery storage; whilst an important area and component of the green energy transition, they lack the stability of income (short-term contracts are quite volatile) therefore they don’t quite tick all the boxes as yet
- Carbon capture/storage/hydrogen – whilst interesting and lots has been spoken about them, they are not mature enough for us to invest in at present and some prices are too inflated with little substance
Whilst we are on the subject of sustainability
Almost every day, I must receive a communication from an investment house about investing into Sustainable funds. It really is becoming mainstream. The pace of change in this sector is something to behold. The umbrella of ESG (Environmental and Social Governance) is extremely broad and now we are seeing this sector becoming more regulated which is good news for consumers as it means they can better understand where any funds sit within this space. Believe you me, there are wide variances.
Depth of research is the key, and the role of our investment partners is pivotal here in sorting out the ‘wheat from the chaff’. We have seen on many occasions funds claiming to be truly sustainable, only to discover that they only meet sustainable criteria for a narrow spectrum of ESG.
When we experienced the recent wobble in sustainable stocks, I read articles suggesting that sustainable investing is a fad. We concur with all our investment partners that this is here to stay as it’s becoming embedded into our personal psyche, that of companies and now it’s being supported and funded by governments.
LGTV and Sustainability
Phoebe Stone, the Head of Sustainable Investing at LGT Vestra, reinforced that the sustainable portfolios have a bias towards growth portfolios which in part helps explains the short-term underperformance. It follows that there are lots of developing companies within this space as innovation is a main driver. However, Phoebe wanted to reinforce that they are focused on investing into good quality businesses with robust business models and wherever possible, predictable earnings streams.
It’s also interesting to note that value stocks by their nature typically have low ESG scores.
Phoebe also spoke about ‘impact’ stocks, those companies which are able to demonstrate the positive impact they are making as opposed to companies who may be adhering to ESG requirements but aren’t having a dynamic effect on the environment. In other words, being able to demonstrate a quantifiable environmental and social impact. Such funds are becoming more and more prevalent which is good to see.
Francis Chau (LGIM) likes alternative assets, and they are embracing the decarbonisation theme where they can. He mentioned forestry and Japanese railway stocks as appearing attractive.
Inflation
I’ve given you a lot to read today and if you have reached this stage, please accept my hearty congratulations. So, just bullet points and a summary of the main drivers from Sanjay at LGT Vestra:
Short-term inflationary pressures
- The vaccine roll out will kick start economies
- Pent up spending demand… although this may have been overestimated in some quarters
- A falling dollar
- There may well be short-term supply chain constraints pushing up prices, especially in the UK with Brexit
Longer-term deflationary pressures
- Demographics of countries suggest more elderly populations in some parts of the world
- More local supply chains as China decouples from the west
- Improvements in technology
Our view, in harmony with LGT Vestra, is that inflation in a longer-term context will remain low and so will interest rates. We are entering a transitionary change as opposed to a systemic change in inflation.
The outlook for the markets
Ben Kumar of 7IM spoke about the current cycle lasting until 2023. He also highlighted a point I’ve made before about the financial crisis and how in monetary and strategic terms, we should be thankful because it actually prepared the ‘powers that be’ for the pandemic. This allowed central banks and governments to act quickly.
Ben talked about having a level of manageable inflation and doesn’t believe we should get overly concerned.
It has been evident that the markets have been at odds with what the Federal Reserve in the US was saying, but Sanjay reminded me of the phrase ‘don’t fight the Fed’. They will do whatever it takes. Of course, some inflation is good. After all, this is what the stimulus was designed for!
Ben spoke about the importance of having blended portfolios and how a combination of passive (indices) and active (managed) approaches are likely to bear fruit. He spoke about lots of short-term rotations as economies come out of lockdown and expect an ebb and flow between growth and value stocks.
Ben also mentioned that we need to consider a world without the US being the outstanding performer in markets. Their strategies are preparing for this. LGIM are of the same opinion and their rotation away from the big five tech stocks appears to have been a wise move, although sectors like artificial intelligence and robotics still suffered collateral damage in the recent correction. A similar adjustment was made within the Blue Sky internally managed portfolios.
Francis Chua of LGIM spoke about a broad commodity play and whilst notoriously being volatile, this sector is worthy of consideration with a global economic recovery underway. We are evaluating the possibilities for this to be added into our Momentum portfolio but for the time being we have some exposure in the higher risk portfolios via LGIM.
Francis also stated that LGIM are neutral to positive regarding emerging markets, but they are wary of a weaker dollar. Many emerging countries however have recapitalised and restructured making them potentially a less risk investment than in yesteryear.
In summary, the consensus view is:
- We are positive with regards to equities, with a weighting still towards growth stocks. A blended approach however is attractive
- Corporate credit (bonds) we have a neutral to positive view. Bonds still act as protection against equities
- Government debt is negative but moving towards a neutral stance after recent volatility. US Treasuries are favoured as are other countries such as Australia and New Zealand
I’ll leave the last word with Francis; “we approach the rest of 2021 with measured optimism”.
Thank you for reading and thank you for your support.
I promise next week’s update will be very short!
Gary and the Blue Sky Investment Team
Risk warning
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.