Our Asset Allocation in Detail

DISCOVER OUR ASSET ALLOCATION IN DETAIL

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EQUITIES

Favourable momentum

The world's leading equity indices continue to rally as inflation gradually abates in most economies. We are sticking to our Neutral position in equity markets, with a European Overweight, to keep participating in this favourable momentum.

US. United States equities have been booming in recent months. The S&P 500 is up by more than 5% on the month and the Nasdaq 100 by 11%. These rallies largely reflect investors' enthusiasm for artificial intelligence and tech sector large caps. Outside the tech sector, market gains have been less impressive. Hopes for AI have led analysts to upgrade their revenue forecasts. However, the market rally is out of kilter with the latest economic figures, which point to modest growth. At the last meeting of the Fed's open markets committee, Chair Jerome Powell confirmed the Bank would be keeping rates high for the next few quarters, and markets have finally adjusted their expectations to not reflect any rate cuts this year. We are therefore holding at Neutral on US equities.

Style Preference

UK. Unlike other developed equity markets, the FTSE 100 fell back nearly 2% over the month. The underperformance is explained by its heavy exposure to the energy sector, hard hit by falling commodity prices in recent months. However, we remain Overweight UK equities. It is still trading on attractive multiples - in fact, it is the cheapest developed market on earnings estimates – and the British internationals dominating the flagship FTSE 100 index remain relatively well insulated from domestic economic woes.

Europe. European equity markets continued to do well. The equity index is up 2.5% on the month, driven by Growth sectors, the AI rush and China's post-Covid reopening, which has been good news for the luxury sector. The revenue outlook continues to look healthy, helped by still substantial nominal growth in the economy. Finally, despite recent gains, valuations remain attractive as the average price-to-earnings ratio is in line with its historical average. We therefore remain Overweight Euro area equities.

Expected earnings per share

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Japan. Japan has been the top performing developed market year to date, up 23% in local currency (14% in sterling). Its rally is grounded in a devaluation of the yen, a more balanced economic growth picture and the prospect of effectively escaping the deflation trend. Nevertheless, we remain at Underweight on Japanese equities. Several indicators, including salary trends, suggest it will be some time before we can call the end of deflation, which in turn pushes back the exit from the yield curve control policy.

Emerging markets. The disappointing trend in Chinese growth since the economy reopened and major geopolitical risks continue to weigh on emerging market equities. We are Underweight.

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

Pending the end of the tightening cycle

Central banks are nearing the end of their policy tightening cycle and likely heading for a pause, particularly in the US. We remain Neutral on government debt and continue to monitor well-rated corporate debt for favourable entry points.

rates

US. US Treasuries have been broadly stable all year despite spasms of volatility during the banking wobble and debt ceiling negotiations. 10-year yields are now close to 3.8% and 2-year bills are paying over 4.5%. May inflation figures confirm price rises are slowing. Headline inflation was 4% in May, its lowest since March 2021, and the core figure was 5.3%. The path down for inflation continues to be muddied by the ongoing resilience of the United States jobs market. New job creations remain solid, unemployment is low and wage rises have only eased slightly. Given this context, Fed committee members kept rates on hold at their June meeting. We are getting near the peak of the tightening cycle, but the Fed will want to be sure underlying inflation remains on a sustainable down trend before committing to a pause. Recessionary fears have receded of late and markets have readjusted their expectations to match, falling into line with our scenario, and now expect rates to plateau at the end of the year (vs. July previously). We are Neutral.

UK. Gilt yields have been on the up all year, recently challenging the “mini-budget” highs of 2022. Inflation is proving stickier than in other developed economies. The headline figure is still too high, remaining steady at 8.7% in May. More concerningly, core inflation ticked up in the most recent reading, reaching 7.1% from 6.8% the month prior. Wage pressures remain strong, with private sector wages up nearly 8% in April. This is partly due to a recent rise in minimum wage but largely due to continuing labour shortages exasperated by a surge in long-term sick workers as well as lack of EU immigration in the wake of Brexit. Persistently high inflation and labour market pressures should persuade the Bank of England to continue its monetary policy tightening. Markets, too, have upgraded their expectations for policy tightening, triggering a general rise in yields. Overall, we remain Neutral on Gilts.

Duration Preference

Eurozone. Yields on Euro area sovereign debt have been broadly stable all year. June figures confirmed inflation is falling rapidly, thanks to better base effects and a fallback in energy prices. Inflation was 6.1% against 6.3% expected, a sharp drop from the peak seen late last year and from the prior month. Core inflation is running at 5.3%, still too high but showing signs of slowing down. Labour markets in the zone are still holding up. At its last monetary policy meeting the ECB hiked rates by 25 bp to 3.50-4.00%. We expect another quarter-point rise before it calls a prolonged halt. Meanwhile headline inflation is likely to continue falling steeply over coming months. Overall, we remain Neutral on Euro area sovereign debt.

CREDIT

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

Real rates
(Interest rate swap – Inflation swap)

Currencies

Closing spreads sustaining EUR and GBP

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. The dollar held broadly stable against leading developed and emerging market currencies last month. While it made initial gains against major developed currencies, particularly the yen, the hawkish tone struck by central banks helped European currencies regain ground. On the emerging market exchanges, Latin American currencies continue to climb against the greenback, with the Mexican peso and Brazilian real up 1.5% in the past 4 weeks. But Asian currencies continue to lose ground. The renminbi fell back 2.6% in an environment where Asian policy rates are lower than at the Fed and ECB.

GBP/USD. We remain Overweight sterling against the dollar. The pound rallied as much as 4% against the dollar in the recent weeks as the cable rate spread narrowed. The BoE should continue to raise its base rate, currently 5.0%, as headline and underlying inflation continue to trend well above target. Also, as in the Euro area, the trade balance has improved since the beginning of the year which should be good for sterling.

EUR/USD. The euro traded broadly flat against the dollar last month. The ECB is expected to keep tightening rates for some months yet, taking the deposit rate to at least 3.75% while the Fed is likely to hold steady at 5-5.25%. Rate spreads between the two currencies should therefore continue to narrow, supporting the European currency. The euro area balance of payments is also continuing to improve, with the current account back in the black and likely to stay there thanks to easing energy prices and healthy exports. We remain Overweight the EUR/USD.

USD Index

JPY/USD. 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 expect a gradual exit from the YCC system because Japanese underlying inflation hit 4.1% in April, nominal wages are starting to rise faster than 2% and the system obliges the BoJ to keep buying sovereign bonds even though it already holds over 40% of the total outstanding. We remain Overweight JPY/USD.

Emerging market currencies. China’s plans to internationalise the Renminbi and replace the US Dollar are accelerated as the Hong-Kong stock exchange debuts shares denominated in the currency. Moreover, support from China in addition to the IMF is sought by Argentina as they rush to avoid a currency crisis and the risk of lapsing into hyperinflation. Elsewhere, the capability to freely trade the Naira has now been made possible as Nigeria has scrapped its years-long currency peg. Quantifying the significance of this decision was a 40% fall in value, representing the largest drop in its history.

ALTERNATIVES

Low attractiveness

The high interest rate environment makes diversification into alternative classes less attractive. We remain Neutral on Gold, and limit exposure to industrial commodities, which remain strongly linked to economic growth prospects.

Commodities

Commodities. We remain Neutral on industrial commodities. Prices of industrial commodities have been declining sharply for weeks now, reflecting the disappointing signals from economic and inflation data. Crude is sliding especially fast, despite Saudi steps to prop up prices by curbing its output.

Gold. Having previously taken profits on our Overweight we are staying Neutral on gold. The metal is currently trading at around USD 1,920/oz, but abating tail risks and increased opportunity costs of rising yields have lessened its overall attractiveness.

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.