Portfolio Update

5 APRIL 2022

RATIONALE

You will recall we had previously written that performance for all asset classes this year will likely be underwhelming, and that we think equity markets will largely be range bound with substantial volatility. Though challenging, this environment does create opportunity for active managers to benefit from large swings in markets.

The March quarter has been a fantastic case in point. Persistent inflationary pressures drove central banks and markets to upwardly revise their interest rate outlook last quarter. This, combined with exceptional commodity price strength (discussed in our recent Market Insight) renewed lockdowns in China and Russia’s invasion of Ukraine saw global equities (MSCI World) fall 14.5% from the peak at the start of January to the low on the 7th of March. Equity markets then staged an impressive comeback, gaining over 11% until month end, driven in part by the unwinding of extreme negative sentiment, optimism over a Ukraine solution and perhaps some remnants of the ‘buy the dip’ strategy that worked wonderfully when central banks were ultra-accommodative.

The source of inflation across major economies has moved beyond Covid specific factors and is now broad based and ingrained. This week’s Federal budget in Australia highlights the fact that high inflation is now a key political issue and policy makers are under pressure to control it. With markets now expecting short term interest rates to rise above 3% in the US by the end of next year and by early 2024 in Australia, equity markets will soon begin to price the risk this poses to economic growth and earnings. In addition to rate hikes, the US Federal Reserve is about to commence quantitative tightening, essentially removing the excess liquidity it put into financial markets to support them and the economic recovery.

While equities rallied in the second half of March, bond markets continued to weaken, reflecting the worsening interest rate outlook, and changing role of central banks in the market. Yields on 10-year Australian government bonds now sit at ~2.8%. After the worst selloff in decades, to us this now presents an attractive opportunity to increase our exposure to an asset class we have long been underweight. We also feel that global equities, less than 5% from highs last year, don’t reflect the tighter financial conditions and potential slowdown in economic growth and corporate earnings that is on the horizon.

In a multi-asset portfolio relative value is always important, and in the US, the relative yield between equities and bonds is now at lows of 2.5% as shown in the chart below. This relatively low level implies little additional return for owning higher risk equities vs lower risk government bonds. Given equity markets are back towards their previous highs, we are taking this opportunity to rebalance away from equities in favour of bonds.

Specific changes are shown below, please note to manage liquidity the sell down of Daintree will be placed over 2 separate transactions.

PORTFOLIO CHANGE

Following the changes, the portfolios are now underweight growth assets, driven by a strong underweight (~6%) to global equities and a moderate overweight to Australian equities which with better value and a large exposure to resources are better placed in the current environment.

ASSET CLASS POSITIONING

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