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John Husselbee
John Husselbee 26-01-22

Tactical Asset Allocation Update: Q1 2022

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.

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 most bearish and five 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 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.

Tactical Asset Allocation Update: Q1 2022

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 latest 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 our cash ranking rising from one to two and investment grade corporate bonds falling from three to two, both ultimately moving as a result of rising UK government bond yields in the face of higher interest rates. US small caps also moved down from four to three, as we feel valuations at that end of the market are now closer to highs than in some of the large caps hit by recent selloffs.

Asset class

Q1 2022 Score

Direction of travel

Commentary

Overall

4

We remain positive on risk assets overall although uncertainty has certainly increased, in terms of both central bank policy and geopolitics. After a tough start to the year, we see three factors dominating sentiment for the rest of 2022, namely inflation, interest rates (and other policy tightening) and volatility, with the Russia/Ukraine situation inflaming the latter.


Taking these in turn, we continue to believe inflation should start to fall in the second half of the year as the rolling base effects from Covid shutdowns work their way through the system, particularly as there appears to be little upward pressure on wages.


As for interest rates, our view is that the pace of hiking will be slower than consensus. For the foreseeable future, however, the narrative around markets will be all about rates: if they rise quicker and more than expected, it could be tough for equities; if slower (as we believe), that should be a healthier backdrop, especially for global and value stocks.


While current newsflow is broadly negative, equity markets remain attractively valued (apart from the US) and consumer spending continues to pick up as economies open – however people view the politics behind it, the UK is moving towards a living with Covid strategy, for example.

Within bonds, we appreciate the direction of yields will be upward over time (as interest rates climb) but, as ever, the path will not be linear and we maintain exposure to this asset class for its diversification to equities, some level of inflation protection and increasing income. For now, we remain underweight duration in our fixed income allocation as central banks prevaricate over the timing and extent of rate rises and tapering.

Cash

2

Cash remains a broadly unattractive asset class but we have moved the ranking up to 2 to reflect the fact that, on a relative basis, it looks better as a store of value in a rising interest rate environment. Compared against duration assets such as government bonds, for example, where rising yields will erode capital values, there is a stronger argument for cash, although it is obviously hit by higher inflation.

UK gilts

2

Yields have risen sharply since the Bank of England’s Monetary Policy Committee pushed through a 0.15 percentage point rate rise in December and another 25 basis points at the start of February as it looks to bring inflation to heel. Yields on 10-year gilts have risen from around 0.7% at the start of December to above 1.4% today.

We moved slightly less negative on gilts in Q2 2021 but this asset class remains underwhelming overall, with the bias of risk continuing to be to the upside for yields (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

2

A global basket of currencies and interest rate risks can result in a differentiated return stream from UK gilts. The bias of risk remains to the upside (or the downside in price terms), especially if higher inflation persists.


Again, 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

2

We have moved our ranking on investment grade credit back from three to two, having increased it to three in Q3 2021. That was in recognition that spreads versus government bonds offered a reasonable yield pick-up and strong credit quality but as gilt yields have climbed over recent weeks, the spreads have narrowed and no longer offers as much cushion for the additional credit risk.

Looking purely against gilts, there is still a case for investment grade but we feel the asset class is now less compelling versus recent history.

Index-linked bonds

3

This debt will benefit versus nominal government bonds if inflation continues to run ahead of expectations, although the possibility of higher prices is now more widely anticipated. 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)

3

While still overweight high yield, as the overall risk-on environment should be supportive of prices, we believe moves in spreads have made these bonds relatively less rewarding for their level of credit risk and moved our rating down from four to three in Q3.

Emerging market debt (EMD)

3

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.

Convertibles

3

We continue to see convertibles as providing an attractive risk/return profile thanks to their optionality and bond floor. Our view moved down from four to three in Q4 2021 as we took profits after a strong spell of performance and feel the asset class has potentially peaked for this cycle.

Equities overall

4

While the risk-on environment continues to favour equities, we expect a more volatile year and returns to be lower than seen in the recovery from the sharp Covid shock back in March/April 2020. With the S&P 500 up close to 27% last year, for example, history suggests that after a gain of at least 20% by the index, returns are comparatively muted over the following 12 months, with an average rise of around 8%.


While we see large parts of the US market as prohibitively expensive, not everything is priced to perfection.
From an equity perspective, we continue to have a long-term underweight to the US and favour markets such as the UK, Europe and Japan


In a reflationary environment, we expect the rest of the world to outperform the US, value stocks to outperform growth and small caps to outperform large. These outperformances will not all come at once, however, so we retain prudent diversification rather than making a significant gamble that one particular thesis pays off.

US equity

3

The US is a formidable market with a strong entrepreneurial culture and a roster of world-class companies.


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 as stated, history suggests returns from the S&P are likely to be lower in 2022, with performance after a 20%-plus year tending to sit around 8%.

US small caps

3

Our ranking on US smaller companies has fallen from four to three, bringing it back in line with the overall US market. On some measures, small-cap valuations are close to their highs whereas many larger companies have come off the top amid recent corrections and while not yet compelling, are looking less unattractive.

UK equity

4

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 and a solid recovery, there remains too much pessimism in the price so, tactically, this is an attractive market, especially as the economy moves towards a living with Covid strategy.

UK small caps

4

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

4

Europe remains 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

4

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

3

Our conviction on Japan has fallen (from four to three) and for now, we prefer to spend our equity risk in areas such as Europe and the UK. That said, the country has made great strides in its vaccination effort and after a volatile 2021, recent political upheaval looks to be resolved with new prime minister Fumio Kishida in place.

Japanese small Caps

3

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

4

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 and recent policy shifts in China, as the state aggressively reins back certain sectors, have hit sentiment.


In contrast to most Western policymakers, the People's Bank of China unexpectedly cut a key interest rate for the first time in almost two years in January as figures showed its growth had slowed and it remains to be seen whether these measures can improve the backdrop.
EM equities remain highly geared into sentiment shifts – both positive and negative – and are also highly sensitive to domestic and international politics.

Asian equity

4

As with EMs, Asia is benefiting 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 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

3

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

3

Commodities have rebounded strongly off their lows and are not as attractive a value play today, although the situation with Russia and the Ukraine has clearly create short-term volatility in the oil price. 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

3

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

3

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.

 


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Key Risks 
 
Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested. The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.
 
Some of the Funds and Model Portfolios managed by the Multi-Asset Team have exposure to foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The majority of the Funds and Model Portfolios invest in Fixed Income securities indirectly through collective investment schemes. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. Some Funds may have exposure to property via collective investment schemes. Property funds may be more difficult to value objectively so may be incorrectly priced, and may at times be harder to sell. This could lead to reduced liquidity in the Fund. Some Funds and Model Portfolios also invest in non-mainstream (alternative) assets indirectly through collective investment schemes. During periods of stressed market conditions non-mainstream (alternative) assets may be difficult to sell at a fair price, which may cause prices to fluctuate more sharply.

 

Disclaimer
 
This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances. 
 
This 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. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust. Always research your own investments and if you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances. 
John Husselbee
John Husselbee
John Husselbee has 35 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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