We are still at our maximum risk appetite (within our target risk parameters), having moved up in the wake of Covid volatility and market weakness in April and May 2020. In terms of tactical positioning, we continue to favour equities over bonds and, within this, prefer a range of cheaper regions - Europe, Asia, Japan, emerging markets and the UK - versus the expensive US.
Positive news on Covid-19 vaccine development is a clear reason to be cheerful, albeit with a long road to travel and tough months ahead. What vaccine announcements have allowed is investors to recalibrate their expectations for companies, creating more certainty around valuations with a return to normalised conditions at least in sight. This prompted broader stock market performance in terms of geography and style towards the end of 2020, expanding leadership beyond the US technology names that have dominated.
Given the effect of vaccine news in the latter part of the year, it is little surprise to find improving sentiment. In November’s Bank of America (BofA) Fund Manager survey, figures revealed falling cash levels among professional investors and a net 46% of asset allocators overweight equities, the highest level since January 2018. This saw an increase in exposure to small caps, emerging markets and value, and emerging markets is the asset class most believe will outperform in 2021, ahead of the S&P 500, oil and gold. Technology continues to be seen as the most crowded trade – and all of these show views shifting towards our long-term thinking.
Initial stronger performance in the ’Biden/vaccine bounce’ came from companies benefiting from the economy reopening, such as consumer and leisure sectors, while those positioned for a stay-at-home scenario did less well. We have also seen a pronounced value spike which is positive for our portfolios given the slight value tilt.
As ever, we are cautious about extrapolating short-term data into long-term outcomes but there are undeniably encouraging signs. Exhibit one for the value case is newly inaugurated President Joe Biden’s infrastructure programme and the ‘Green Industrial Revolution’ in the UK, which could be positive for sectors such as industrials, materials, consumer discretionary and – with a potential knock-on impact on bond yields – financials.
We always want to prepare rather than react and believe our calls earlier in 2020 to add small caps, Asia and emerging markets are starting to bear fruit. We added more to US smaller companies towards the end of the year, with improving vaccine news giving greater visibility and supporting risk assets.
Despite the Biden effect in the US, we still have concerns about narrow market leadership and believe tech companies could face further corrections, even without crushing Antitrust regulation. We have therefore continued to reduced exposure to growth and see better opportunities outside the US. As an example, we are more constructive on the UK, despite clear economic challenges in the face of Covid-19, as it offers attractive valuations relative to other regions, has finally cleared the Brexit hurdle and should benefit from faster vaccine distribution, provided the government is up to any logistical challenges.
Japan, meanwhile, remains in the news as the country tries to stage the delayed Tokyo Olympics this year while wrestling with the pandemic. The country clearly has challenges to face but remains cheaper versus other equity markets and we are confident Prime Minister Yoshihide Suga will keep the fundamentals of his predecessor Shinzo Abe’s Abenomics policies intact and also bring greater focus to Japan’s growth strategy backed by a so-called digital revolution.
On fixed income, with interest rates unlikely to rise for the foreseeable future as the world recovers from Covid-19, yields look set to be rangebound at current low levels. That said, bonds continue to fulfil key roles in our portfolios and funds, offering income, capital protection and some inflation proofing, as well as vital diversification away from equities. In our bond allocation, we are overweight high yield, which offers a more attractive risk/return and greater yield than investment grade credit, have some exposure to emerging market debt, and also have a position in index-linked bonds to protect against any uptick in inflation, with many central banks prepared to tolerate rising prices as part of the economic recovery over the next few years.
Thought of the quarter: Bitcoin mania
Bitcoin has been back in the news after the digital currency tripled in value since October, leading to understandable questions about whether we should be considering investing in cryptocurrencies. We had a presentation back in 2018 called Waiting for the Bitcoin to drop and our basic view remains the same – while an interesting story, Bitcoin in its current form is too speculative and volatile for us, particularly given our approach to risk.
A fresh spate of Bitcoin mania over recent weeks has forced the FCA to warn investors that the market for cryptoassets provides little protection for consumers and firms offering them often overstate the rewards and downplay the risks. Earlier in January, for example, Bitcoin surged past an all-time high of $40,000 before collapsing back towards $34,000 in the space of a few hours as cryptocurrencies lost around $150 billion in value. A few days later, it had recovered much of these losses, trading back at $39,000, before falling back towards $31,000.
This volatility may ultimately improve if larger investors enter the market but, for now, Bitcoin maintains many of the characteristics of a commodity, with limited supply and people trying to mine it, clocking up significant electricity bills in the process. At best, we would say this is speculation but it is actually more like gambling where you must be prepared to lose all your money. As with any bubble, we could argue this one is built on the greater fool theory, buying because you assume someone else will pay even more and drag the price up further. And as any bubble from history has shown, you do not want to be holding the parcel – in this case, little more than a literal parcel of data – when the music stops.
Money has three traditional functions: a means of exchange, a unit of account and a store of wealth. While Bitcoin might meet the first of these at a stretch – accepted as form of payment by some individuals and businesses – it fails on the latter two. No goods are currently priced in Bitcoin, understandable with the volatility, and something so vulnerable to a power cut or forgetting a password is hardly set to replace gold as a store of wealth.
As part of our investment process, we are always wary of fads and fashions, which rarely fit into prudent portfolios. Our approach is that an asset’s contribution to the risk budget is as important as its potential impact on future returns and, with so little track record available for cryptocurrencies, it is all but impossible to draw meaningful conclusions on their volatility or performance potential.
As with more traditional currencies, there is also no reliable way to predict as and when they may appreciate in value. More importantly, there seems no obvious role for such an unstable asset class in a portfolio: unlike stocks or bonds, for example, it is not clear that cryptocurrencies are trying to offer positive returns.
At present, Bitcoin seems to encapsulate get rich quick thinking: people are effectively gambling and as every betting advert says, they should only risk what they can afford to lose. In contrast, effective long-term investing, for us, is about getting rich slowly. A quote from influential investor Benjamin Graham pinpoints this essential difference between speculation and investment: “An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Even if we wanted to take a position, the current operational and administrative challenges would likely outweigh the opportunity. But while we are unlikely to be holding Bitcoin any time soon, it can certainly reveal some interesting lessons about herd mentality.
