As with other long-term investors, CCLA’s multi-asset portfolios have
seen significant falls in capital value over the calendar year to date.
‘Alternative’ assets such as commercial property and infrastructure have on
balance delivered positive returns, but these have been outweighed by negative
returns from the funds’ dominant equities component
Why have equity markets been doing so badly this year?
In the early weeks of 2022, weak sentiment in global equity
markets was driven primarily by investor concern over central banks tightening
monetary policy, which would increase the cost of borrowing and therefore put
pressure on asset valuations. In other words, this was mainly a pricing effect
rather than a reflection of pessimism about company earnings.
More recently, and exacerbated by the economic and financial
impact of the war in Ukraine, these concerns have shifted towards a fear that
inflationary pressures are pushing the global economy towards a slowdown and
potentially a recession in some major economies. Declining consumer demand and
rising costs both have negative implications for corporate earnings. In
addition, China’s covid lockdown policies are also acting as a headwind to
growth and damaging market sentiment in the industrial sector. These
factors are impacting earnings data, which is in turn causing volatility in
markets, although they do not necessarily indicate that we are heading into a
global recession.
Where might the markets go from here?
Having fallen significantly since the beginning of the year,
the major equity markets are no longer looking expensive. In the US markets,
which dominate global investment, the S&P500 and the tech-heavy Nasdaq
indices are both trading at or just below their 10-year average price to
earnings ratios. [1]
We do, however, expect equity markets to remain challenging
for the next few months in response to worsening macro-economic data. For this
to improve, we need to see an easing-off in the inflation data, and indications
that the economic growth outlook is stabilising rather than deteriorating.
Neither of these is likely to happen until later in the year.
We still expect inflation to begin to fall back before the
end of 2022, as the year-on-year rate of price increases should start to
decline once we pass the anniversary of the initial sharp spike in energy
prices which occurred in the autumn of 2021. However, the extent to which the
market may fall further from here will depend principally upon whether or not
the global economy avoids recession.
Portfolio update
Consistent with our aim to deliver strong long term returns
from diversified portfolios, in CCLA’s multi-asset funds, we maintain our focus
on global equity markets. We remain
alert to changing market conditions and to protect our clients portfolios we
have been making incremental changes:
·
Towards the end of 2021, we reduced our exposure
to what we deemed to be overpriced equity markets by raising the amount of cash
·
In March 2022, as the market largely recovered
from the downturn that had followed February’s outbreak of war in Ukraine, we further
raised cash from the equity portfolio and added to our alternatives exposure
where we are seeing genuine inflation protection and diversification.
·
We continue to avoid the bond markets, on the
basis that inflation and rising interest rates are inherently damaging to
returns from fixed income assets.
Cyclical industries such as the traditional energy (oil)
sector do not have the quality and growth characteristics that we seek, as
demand is highly correlated with global macro-economic conditions. Within the
equity book we generally have less ‘cyclical exposure’ than the market itself,
meaning that our portfolios’ returns are not closely linked to the changing
fortunes of the wider economy. Instead, we remain focussed on quality companies, with stable and growing cash
flows, at attractive valuations. We tend to avoid the energy and
commodities sectors altogether and are considerably underweight banks and industry
groups like mining, autos, supermarkets and other economically sensitive
sectors.
In the calendar year to date, our positioning has moved
further towards a defensive stance. We have reduced holdings in consumer
discretionary businesses such as Adidas, recognising the pressure on consumers’
real disposable income that results from higher inflation. We have further trimmed
the portfolio’s exposure to banking, a sector which is vulnerable to slowing
economic growth.
We have redeployed some cash by adding to a handful of
positions where we see more defensive properties, such as selected consumer
staples and technology businesses.
Reflecting our wariness of the outlook for markets, we are
still holding cash balances which are high relative to the norm for our
multi-asset portfolios, and we remain cautious in reinvesting this, seeking to
apply it only where we see a clear opportunity to add value by acquiring high
quality assets at attractive prices.
Performance update
Our philosophical preference for quality and secular growth
positions us in stocks that:
·
are less economically sensitive
·
have less exposure to the damaging effects on
margins of high and persistent inflation.
The characteristics of our equity portfolios confirm that
these stocks have superior profitability indicators (margins, returns, leverage
etc) with superior growth credentials (sales and earnings growth).
The market’s recent response to the prospect of tighter
monetary policy has been most marked in the valuation of growth stocks. This is
because for these stocks, today’s prices depend significantly on future
earnings, and a higher interest rate environment means that these earnings are
steeply discounted back to arrive at today’s value. Our bias towards quality
growth has therefore had a detrimental effect on relative returns over the
calendar year to date. The most significant factor has been because we do not
invest in the traditional energy sector which has fared strikingly well over
the year to date, because companies in that sector do not have the qualities
that we seek for our portfolios.
Looking ahead, as the dominant influence on market pricing
shifts from tightening monetary policy towards an assessment of companies’
earnings prospects at a time of lower economic growth, we would expect the
relative performance of our equity portfolios to improve as a result of our
focus on quality.
Elsewhere in the multi-asset portfolios, a high proportion
of our holdings in alternative assets are well placed to contribute positively
to returns, even at times when inflation is elevated, and economic growth is
weak.
Income
Income distributions to fund unit holders, supported by the
underlying free cash flow attributable to our funds’ portfolios, are not
directly affected by volatility in capital values and are expected to continue
as previously forecast.
Important information
This document is issued for information purposes only. It does not constitute the provision of financial, investment or other professional advice. Past performance is not a reliable indicator of future results. The value of investments and the income derived from them may fall as well as rise. Investors may not get back the amount originally invested and may lose money. Any forward-looking statements are based upon CCLA's current opinions, expectations and projections. Such opinions, expectations or projections may be subject to change at any time. CCLA undertakes no obligations to update or revise these. Actual results could differ materially from those anticipated. CCLA Investment Management Limited and CCLA Fund Managers Limited are authorised and regulated by the Fin