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Tactical Asset Allocation update: Q3 2021

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

Tactical Asset Allocation (TAA) is one of the five stages of the Multi-Asset investment process – the others being Strategic Asset Allocation (SAA), fund selection, portfolio construction and monitoring.

The Multi-Asset investment team has a medium term view – 12 to 18 months – of the prospects for each asset class and this forms the TAA. Each asset class is assigned a rating from one to five, with one the most bearish and five the most bullish. TAA is the target (not the actual position) for every asset class and the investment team builds towards this within the funds and portfolios over time. Having a 12 to 18-month view means the team will increase their positions when the valuations of the asset classes are attractive; their core approach is to buy low and they will not overpay for assets, however highly they score.

The team reviews TAA every quarter but it is important to stress this does not reflect a quarterly view. The rating is only altered up or down when there is a fundamental change in the assessment of a particular asset class, and by taking a longer-term view, the team is seeking to ignore short-term market noise and avoid trying to time the market. The table above shows the current TAA and includes all asset classes regardless of whether they are included across the funds and portfolios. The direction of travel arrow shows the last change in the TAA, whenever this occurred.

Changes in this latest version (highlighted in green and red) are fairly small, with a modest de-risking of bonds as investment grade moves up from two to three and high-yield falls from four to three. This is in the context of a fairly underwhelming outlook for bonds overall and our view remains that, in the current environment, it makes more sense to spend your risk budget in equities. That said, we always maintain an allocation to fixed income and feel that while investment grade spreads versus government debt offer a reasonable yield pick-up and bring credit quality to our portfolios, recent moves in high-yield spreads make these bonds relatively less rewarding for their level of credit risk, although we remain overweight.

Asset class

Q3 2021 Score

Direction of travel




Overall, we remain positive on risk assets but acknowledge challenges to this view, from growth disappointments (particularly countries struggling to meet aggressive predictions) to future Covid-19 mutations. There remain plenty of positive impetuses, with pent-up corporate and consumer demand still being released, vaccine distribution continuing (albeit with many Asian countries lagging), and monetary and fiscal policy still supportive.

While central banks are discussing tapering asset purchases this year, they have stressed interest rate rises are still some distance away and continue to insist current higher levels of inflation are transitory.

Although aggressive tightening is not on the agenda, the world needs to get comfortable with a new status quo where crisis-level monetary policy is no longer essential. Assuming vaccination efforts continue and the pandemic recedes, we see the global economy moving into a mid-cycle expansion, with the focus shifting from recovery to more sustained growth.

Following recent peaks in policy support, growth and markets, we would expect to see global GDP moderate to above-trend levels next year and more active stock selection will be required in such an environment, with the broad rally since last year’s vaccine announcements thinning out.



Cash offers little to no prospect of a real return in the coming years, with major central banks remaining committed to loose policy. Cash does have the benefit of offering a store of value at times of market stress, so a modest allocation may be appropriate depending on the mandate.


UK gilts


Yields have risen off their extreme lows in recent months and we moved slightly more constructive on gilts in our Q2 TAA review. This asset class remains underwhelming overall, however, with the bias of risk continuing to be to the upside (or to the downside in price terms), especially if higher inflation persists. Gilts still provide a useful function as portfolio insurance in times of market duress but offer little more than a cushion to equities.


Global government bonds


A global basket of currencies and interest rate risks can result in a differentiated return stream from UK gilts. Yields remain close to all-time lows and the bias of risk looks to be to the upside (or the downside in price terms), especially if higher inflation persists. These bonds still provide a useful function as portfolio insurance in times of market duress but offer little more than a cushion to equities.


Investment grade (IG) corporate bonds


We have increased our rating on investment grade credit from two to three, in recognition that spreads versus government bonds offer a reasonable yield pick-up while providing strong credit quality. In times of market stress, this debt should also benefit from its inherent duration.


Index-linked bonds


This debt would benefit versus nominal government bonds if inflation proves to be ahead of expectations, although the possibility of higher prices is now more widely anticipated than it was last year. Index-linked bonds tend to have longer duration than the same tenor nominals so duration positioning needs to be considered. Big moves out in yields will also impact these bonds. It is best to buy inflation protection when the risk is underappreciated, which is not the case today.


High yield (HY)


While still overweight high yield, as the overall risk-on environment should be supportive of prices, we believe moves in spreads year to date make these bonds relatively less rewarding for their level of credit risk and have therefore moved our rating down from four to three.


Emerging market debt (EMD)


Spreads look reasonable but the idiosyncrasies of the emerging market environment are potentially better rewarded in EM equities. Furthermore, US dollar- denominated debt will be subject to moves in the US yield curve. There is some potential for support from a softer US dollar, better liquidity than expected, and carry hunters.




The composition/concentration of global indices is a negative, as are valuations. But a positive overall market backdrop supports convertibles, which provide an attractive risk/return profile thanks to their optionality and the bond floor.


Equities overall


The risk-on environment continues to favour equities. Markets have come a long way from the 2020 lows but this is largely justified by government spending and decent corporate results.


More recently, market leadership looks to be shifting back towards growth, away from the value and cyclicals that have driven most of the rally this year. We would caution against immediate assumptions the value rotation is over, however. In valuation terms, value still looks attractive, despite the recovery this year, while many growth sectors remain expensive, particularly the mega-cap end of the US market.


As we have always stressed, the case for longer-duration growth companies builds in assumptions looking far into the future and many could be vulnerable to changing conditions; if investors are concerned about rising government bond yields, that caution should extend to overpriced growth equities.

Meanwhile, value has underperformed for many years and we feel the recent recovery may ultimately prove the first leg of a multi-year retrenchment.


US equity


The US is a formidable market with a strong entrepreneurial culture and a roster of world-class companies. From a policy perspective, the Federal Reserve looks set to be first off the blocks with tapering but assurances that rates hikes are still way into the future appear to have prevented a 2013-like tantrum for now.

Valuations look elevated for the index overall, although the picture is better outside of mega-cap growth. A shift back towards ‘real world’ rather than virtual interaction will put pressure on technology revenues and, overall, share prices have discounted better-than-expected earnings.


US small caps


Despite our overall caution on the US, we see smaller companies as ripe for a rebound in light of their significant underperformance versus large caps. As the recovery broadens, investors will be looking elsewhere and consumers flush with cash should benefit domestically orientated companies, especially small caps. As the economy reopens (we are bullish about the cycle), small caps should outperform large. A risk to this would come from tax hikes, which tend to hit small and mid-cap companies more than their larger counterparts.


UK equity


The UK was hit from all sides in 2020 with Covid impact, sector composition (heavy in struggling resources, financials and energy), and Brexit combining to make it the most unloved major market. Despite its global revenue base, there is too much pessimism in the price so, tactically, this is an attractive market. A strong pound is likely to be a headwind, however.


UK small caps


A strong rebound in UK smaller companies is already under way but there is further scope for mean reversion with Brexit uncertainty disappearing, sterling normalisation and further merger and acquisition (M&A) activity. Enhanced economic activity thanks to vaccine rollout should also provide impetus to domestic-orientated names.


European equity


Europe’s vaccination effort continues to improve and the region has been a major beneficiary of a global recovery and normalisation. Export-led European stocks are geared into a global recovery and consumer brands should benefit from high levels of spending power turning on post lockdown. Overall, valuations look attractive and Europe is further along the environmental, social and governance (ESG) path on a company by company basis than other markets.


European small Caps


European small caps are under similar pressures to their larger counterparts but should be well positioned to take advantage of global reopening and increased domestic consumption on the continent. Prospects would come under pressure should governments accelerate their plans to balance the books.


Japanese equity


Japanese equities, with a large proportion of export-driven businesses, are well placed to benefit from the global economic rebound. Questions nag in the short term over the ability of the economy to recover its stride as vaccine rollout lags other developed markets. Japan remains lowly valued compared to other developed markets. Exporting stocks tend to benefit from yen weakness so local currency strength could provide a headwind to returns.


Japanese small Caps


Japanese small caps are under similar pressures to their large counterparts but should be well positioned to take advantage of global reopening and increased domestic consumption.


Emerging markets equity


Emerging markets will benefit from the global reflation trade, with loose monetary policies and a weak US dollar also providing a supportive environment. Long-term fundamentals remain intact but shorter-term pandemic shocks, with generally slower vaccination rates, and recent policy shifts in China, as the state aggressively reins back certain sectors, continue to hit sentiment. EM equities remain highly geared into sentiment shifts – both positive and negative – and are also highly sensitive to domestic and international politics.


Asian equity


As with EMs, Asia is benefitting from the reflation trade and loose monetary policies and a weak US dollar also provides a supportive environment. These economies have, on the whole, fared well through the Covid crisis but slower vaccination rates and China’s recent moves against sectors such as tech have hit sentiment. Risks remain from the perspective of global sentiment as well as regional political tensions.




Property offers a reasonable yield pick-up compared to many other asset classes and price moves in 2020 imply that a lot of bad news is already factored in. Capital values are starting to rebound but rental growth is decelerating. There is also uncertainty surrounding a number of property types in a post-Covid world: the anticipated demise of the office and high street retail sectors could well be overstated but current pressures on tenants will have long-term repercussions.




Commodities have rebounded strongly off their lows and are not as attractive a value play today. Over the medium to long term, they should remain correlated to continued positive news on global economic activity. Broad allocations to commodities should also provide some protection if inflation surprises on the upside. Conversely, downward price pressure could resume if growth disappoints following the initial post-Covid recovery.


Hedge funds


Given time, the right hedge fund strategy can provide a diversified return stream compared to more traditional asset classes. These funds are unlikely to keep up with a raging bull market but should post reasonable returns in a constructive environment for risk assets.


Absolute return


Well-chosen absolute return vehicles can be a useful diversifier to overall portfolio risk thanks to their low correlation with traditional asset classes. But they are unlikely to keep up with ultimate safe havens such as government bonds in times of market duress.


Understand common financial words and terms See our glossary

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well-regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

John Husselbee
John Husselbee
John Husselbee has 38 years’ experience managing multi-asset, multi-manager funds and portfolios. Before joining Liontrust in 2013, John was co-founder and CIO of North Investment Partners and Director of Multi-Manager Investments at Henderson Global Investors.

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