Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

Retaining a Preference for Europe

The main equity indices continue to rally as the result of favourable inflation numbers across the developed world. We are sticking with our Neutral position in equity markets, with a European overweight, to keep cashing in on its favourable earnings momentum.

US. US equity markets have made further gains, putting on 3.5% so far in July. Since the beginning of the year, the S&P 500 has risen 21% in dollar terms while the tech-heavy NASDAQ index has leapt an impressive 37%. These gains reflect the solid resilience of the US economy and ongoing enthusiasm for the artificial intelligence sector. Putting the “significant seven” – the seven largest names in the flagship S&P 500 index – aside, its performance has been less impressive; although the breadth of the recovery is starting to increase. Accordingly, we remain at Neutral on US equities and retain a balance between growth and value sectors.

Style Preference

UK. UK equity markets had a less than rosy start to July, struggling with a fall in commodity prices and the deterioration in the country's economic outlook. However, inflation figures came in below expectations at both headline and core level, propelling the flagship FTSE 100 index by more than 6% from its inter-monthly lows. We remain Overweight on this market given valuations remain attractive relative to their historical values.

Eurozone. Equities in the euro area levelled of following their strong advance in the year to date, remaining flat over the last four weeks. Nevertheless, since the start of the year, European equities have risen by 16%, with growth and value stocks experiencing a similar growth rate. Despite severe monetary tightening, European economic activity remains resilient. This is driven by the resilience of the services sector while manufacturing activity remains broadly stable despite various headwinds. Furthermore, over the next few quarters, the outlook for profits remains favourable against a backdrop of strong nominal growth. Finally, compared with bond yields, equity yields remain attractive. Considering these factors, we remain Overweight on euro area equity markets.

Real equity risk premium

Source: SGPB, Macrobon, Macrobond 12/07/2023

Japan. The Japanese market remains the best performing of the developed markets, up almost 26% in local currency (11% in GBP) since the start of the year. This performance reflects the prospects of "more balanced" growth and expectations of an end to deflation. Notably, several indicators including wage trends indicate that it is still early to talk of a change in the deflationary regime. We remain Underweight on the Japanese equity market.

Emerging markets. We remain Underweight emerging market equities, given the disappointing recovery in the Chinese economy and major political and regulatory risks across these regions.

Past performance does not prejudge future performance. Investments may be subject to market fluctuations, and the price and value of investments and the resulting revenues may fluctuate downward and upward. Your capital is not protected, and original investments may not be recovered.

FIXED INCOME

Increasing Duration

We remain Neutral on bond markets, increasing our exposure to longer maturities, given the impending end of the central bank tightening cycle and the continued moderation of inflationary pressures.

rates

US. Treasuries have experienced high volatility over the past months amid positive surprises in activity and inflation as well as a renewed restrictive narrative from the Federal Reserve. Reaching 5% following strong employment data, the 2-year Treasury rate fell to 4.6% following the publication of the latest inflation print. Yields on 10-year Treasuries followed the same trend, touching 4.1% to fall to 3.8%. Overall, given the resilience of the labour market and activity, the Fed reaffirmed its restrictive tone with a further 25bps hike in July, bringing its range to 5.25%-5.5%. We remain overweight on US dollar Treasuries. Indeed, the entire curve offers positive real rates, reflecting the recent rise in nominal rates and the decline in the inflation outlook. In addition, we believe the latest hike was likely the last of this cycle given the prospects for faster core disinflation than in first half of 2023.

UK. The Gilt market has been one of the worst government bond performers for most of the year. The total return bond index is down 6% since January. This poor price performance (or sharp rise in yields) is due to the specifics of British inflation, which remained at 7.8% in May before finally slowing more than expected, to 6.9%, in June. Still, the Bank of England (BoE) is projecting a steeper path of monetary tightening than its peers, causing us to maintain our Neutral position on Gilts but with a preference for longer dates. The monetary policy squeeze will likely push the UK economy into recession and place heavy pressure on the property market, at which point the BoE would have to begin cutting rates. Collectively, these conditions are favourable for long duration bonds in the medium term.

Duration Preference

Eurozone. European sovereign yields followed the momentum of US rates, with the 10-year OAT reaching 3.25%, their highest level since 2012, to return to 3%. All in all, the high volatility on rates reflects the very restrictive tone of the ECB which increased by 25bps in July and does not rule out further increases for the rest of the year. It is concerned about core inflation, which remains at 5.3%, in a context of still tight labour markets. Thus, we remain neutral on European bonds but with a marked preference for long maturities. The rapid decline in headline inflation and the underlying disinflation suggested by survey data should translate into higher real rates. At the same time, given this inflation outlook and less favourable activity data, we believe the July hike should be the last of the tightening cycle, favouring longer-term bonds.

CREDIT

Developed markets. We remain Underweight corporate credit, specifically with a view to the riskier high-yield space, in an environment of higher rates and increasing default rates.s.

10y real government yields

Source: SGPB, Macrobon, Macrobond 12/07/2023

Currencies

Favourable Tailwinds for European Currencies

We remain Overweight the euro and sterling versus the dollar as the transatlantic monetary policy gap continues to narrow and Europe’s balance of payments improves.

Dollar Index. Over the past four weeks, the dollar has lost ground against the currencies of developed economies and made gains against the leading emerging market currencies. The US dollar has rallied in its major Asian crosses (including a 0.6% gain against the CNY) as these countries’ lower inflation allows them to run more accommodative monetary policies. In contrast, Latin American currencies continue to rally (MXN/USD +1.5% and BRL/USD +0.2%) reflecting the decline in inflation in these economies and a serious rate gap with the Federal Reserve.

GBP/USD. We remain Overweight sterling against the dollar. The pound rallied as much as 3.4% against the dollar in July as the cable rate spread narrowed, before easing as a result of better-than-expected inflation figures. The BoE should continue to raise its base rate, currently 5%, as headline and underlying inflation continue to trend well above target. UK’s continuing improvement in trade balance since the beginning of the year should provide further support over the coming months.

EUR/USD. The euro put on 1.75% against the dollar over the last month and steadied at 1.10. The ECB will probably maintain a more hawkish tone than the Fed which has already paused its tightening cycle. Rate spreads between the two currencies could narrow further and help support the European currency. The Eurozone’s balance of payments continues to improve, with the current account back in the black and likely to stay there given easing energy prices and healthy exports. We remain Overweight EUR/USD.

USD against main currencies

JPY/USD. Despite an initial surge in July, the yen continues to fall against the dollar as the rate gap between the two currencies has widened. Japan is, for now, sticking by its yield curve control system, in which the Bank of Japan caps the 10-year JGB yield at 0.5%. Markets are still expecting a gradual exit from this system, as Japan's May inflation was 3.2% in May and core inflation was 4.2%. However, nominal salaries are only inching upward – by 0.9% in the year to April – and this is likely to push back the BoJ’s decision to exit its monetary strategy.

Emerging market currencies. Western sanctions have been troubling the Russian Rouble since Russia’s full-scale invasion of Ukraine, but this month it has sunk to its lowest level against the dollar since the start of conflict. Meanwhile, demand for Latin American currencies have increased as the region’s high interest rates combined with low inflation and more resilient economies than anticipated make an attractive investment proposition. Elsewhere, China continues with its objective of internationalising the renminbi. Despite positive take-up in Russia however, latest data suggests efforts so far have not produced any significant results globally.

ALTERNATIVES

Diversification is Key

The high interest rate environment makes diversification into alternative asset classes less attractive. We are maintaining our Neutral position on commodities and gold. Hedge Funds may have lost some of their shine compared fixed income products, yet they remain a core pillar of our diversification strategy.

Commodities

Commodities. We remain Neutral on industrial commodities. Bloomberg’s commodity index recovered in July – as did crude oil prices – but lacklustre growth projections, specifically with respect to the Chinese economy, will likely continue to provide a drag on commodity prices in 2023.

Gold. In July, gold benefitted from gradually waning inflation figures and investors’ re-assessment of central bank action for the remainder of the year. We remain Neutral, having taken profits on our Overweight position a few months ago.

Commodity Prices

Real Assets

Infrastructure & specialist property. We hold an allocation to a diversified portfolio of infrastructure (such as energy storage and efficiency, smart grids, waste-to-energy, air treatment and digital infrastructure) and specialist property assets (including care homes and e-commerce and logistics warehouses). These real assets offer additional diversification from other risk assets such as equities, as well as an attractive income stream and reasonable sensitivity to inflation.

Hedge funds

Hedge Funds. In unstable market conditions hedge funds can help a portfolio, but selectivity is key. We prefer strategies which hold their own in bear markets, such as Merger Arbitrage, trend followers and Equity long/short. These strategies provide relatively safe, uncorrelated sources of returns from equities. Our hedge funds allocation has performed well over 2022 and have been a great diversifier in our strategies.

Tail Risk Protection Note. Tail risks are typically understood as unlikely but severe crisis events which shock markets and dramatically impact the value of risk assets negatively. The dot-com bust at the turn of the century and the Great Financial Crisis in 2008 and 2009 are examples of such events. Despite conditions not being favourable for it in 2022, we believe the Tail Risk Protection Note offers our portfolios yet another critical source of safety and complements the existing diversifiers.