Tactical Asset Allocation update: Q4 2021

Liontrust Multi-Asset Team

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.

Liontrust MA TAA scorecard Q4 2021

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 red) are fairly small, with convertibles and Japanese equity both moving down from four to three. Within convertibles, we are taking some profits after a strong spell of performance for the asset class, which we feel has potentially peaked for this cycle. As for Japan, our conviction has fallen slightly although recent political upheaval looks to be resolved with new prime minister Fumio Kishida in place. For now, we prefer to spend our equity risk in areas such as Europe and the UK.

Asset class

Q4 2021 Score

Direction of travel

Commentary

Overall

4

We remain positive on risk assets heading into 2022, although the Omicron variant has clearly brought a fresh sense of uncertainty, sparking volatility in markets, and may delay interest rate hikes to some extent. Looking beyond that, we feel that while talk about hikes and tapering might be concerning in the short term, they are ultimately a positive signal on the global economy reaching escape velocity from the pandemic. The economy has come faster to the current mid-cycle point than would be expected, in 18 months rather than the more typical four or five years, but no one should be surprised to see an accelerated cycle given unprecedented levels of stimulus.

Any hikes are expected to be gradual and we should remember that even a 0.5% increase in UK base rates would still mean we are effectively on emergency monetary policy. All the worry around higher UK rates also serves as a reminder that, while this dominates newsflow, we are running diversified portfolios on which the impact of hikes by the Bank of England should be limited.

We also continue to believe inflationary concerns will be temporary rather than long lasting. While headline figures are elevated at present, core levels remain fairly steady. On the former, we are seeing a kind of rolling base effect move through the system, with gas prices causing a spike one month and used cars the next, but none of these are likely to calcify into higher long-term core inflation.

We appreciate the direction of bond yields will be upward over time 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 insurance and increasing income.

 

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. 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

1

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

2

Yields have risen off their extreme lows in recent months and we moved slightly less negative on gilts in Q2 2021. This asset class remains underwhelming overall, however, 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. Yields remain close to lows and the bias of risk looks to be to the upside (or the downside in price terms), especially if higher inflation persists.

 

We would suggest any forthcoming policy tightening is already in the price and Jay Powell’s re-appointment as Federal Reserve chair brings a sense of consistency into next year. 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

3

We increased our rating on investment grade credit from two to three in Q3 2021, in recognition that spreads versus government bonds offer a reasonable yield pick-up while providing strong credit quality.

 

We feel that with markets having come a long way from Covid-inspired lows, a moderate shift from high yield to IG indicates a sensible risk re-allocation across our funds and portfolios. In times of market stress, this debt should also benefit from its inherent duration.

Index-linked bonds

3

This debt would benefit versus nominal government bonds if inflation continues to run 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)

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 has moved down from four to three as we are taking profits after a strong spell of performance and feel the asset class has potentially peaked for this cycle.

Equities overall

4

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.

 

Across our funds and portfolios, we continue to be bullish on the reflation trade and are positioning for three long-term views: global ex-US equities are more attractive than the expensive US, small caps should outperform large, and value should outstrip growth, all of which run contrary to what happened for most of the 2010s.

 

More hawkish central banks have driven a rotation back into the value end of the market, after a pause over summer, and we feel many of these companies remain very cheap.

 

We currently favour Europe and the UK, with slightly lower conviction on Japan.

US equity

3

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 was first off the blocks with tapering but while chair Jay Powell has signalled his support for earlier-than-expected rate rises, Omicron will likely delay any decisions 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

4

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

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, 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

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’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

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 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, 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

4

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

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. 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.

 

Liontrust Insights

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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 information 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.  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.

Monday, December 6, 2021, 4:12 PM