Fears over rising inflation and the potential for the traditional response of higher interest rates being applied by central bankers took its toll on portfolio returns in the first three months of 2018. This led to a price decline in both equities and bonds. Globally, equity markets were lower by just over 5% and despite a strong domestic currency during this period, the UK equity market was the worst performer amongst the major global equity regions. Large Financial stocks such as HSBC and the Non-Cyclical Consumer stocks like British American Tobacco, Unilever and Diageo had the greatest negative impact on London listed equities. Companies that control global consumer brand names have been a particular favourite with investors as these businesses tend to have reasonably stable cash flows that allow them to consistently distribute dividends to shareholders. This is where many investors have chosen to deploy capital in the low interest rate, low growth environment of recent years. It follows that if some of the factors underpinning an investment rationale look set to change then these types of assets would come under the most pressure, which is what happened in the first quarter. The typically more volatile equity markets in Asia and other parts of the developing world generally held up better than developed Western equity markets in sterling terms. Normally, we would expect a global deterioration in sentiment towards equity markets to be amplified in Asian and Emerging Market securities. However, in the aftermath of the Great Financial Crisis in 2007/8, Asian and Emerging Markets have accrued a substantial amount of relative value as they have underperformed their developed counterparts for many years. This may explain the muted decline in markets where we would normally expect larger sell-offs during equity market falls. We believe that an appropriate level of investment in Asian and Emerging Markets in line with your attitude to risk continues to represent an attractive opportunity for your portfolio.
Interest rates on government bonds rose over the quarter, pushing bond prices lower. This effect was particularly acute in UK and US bond markets where the inflation pressures and central bankers’ propensity to deal with them by raising interest rates was seen as the most prominent issue. Amongst other things, the effect of potentially higher interest rates in the UK helped sterling climb against the US dollar and euro and continue its recovery from the sharp declines following the vote for the UK to leave the EU. As is often the case during periods of risk aversion, the Japanese yen was the strongest of major global currencies. Large, sophisticated investors such as hedge funds and banks borrow in yen (due to the low interest rate) to fund international investments. When these investments are sold, the borrowed currency is repatriated. The effect on the currency can be dramatic when such activity occurs in a short space of time as in the last quarter. With the deterioration of risk appetite, yields demanded by investors on corporate bonds rose faster than those on government bonds. Consequently, corporate debt underperformed the debt issued by sovereign states. The impact of the substantial rise in high yield rates was partly offset by the generally shorter maturity of these securities compared to investment grade bonds. The shorter the time to maturity for a bond, the less interest rate changes will affect the capital return.
Physical UK Commercial Property was one of the few asset classes that did manage positive returns during the period. Some of the gains made are as a result of unwinding the conservative pricing policies applied immediately after the EU referendum result. This factor has now all but played out and will not be a feature of returns going forward. Yields have been pushed to quite low levels as investors flock to income producing assets and pricing in the Commercial Property market tends to lag pricing in equity and bond markets where general investor sentiment is reflected almost instantaneously.
Although macroeconomic policies over the last decade have had a significant impact in driving asset prices higher we continue to focus in finding areas of value whilst paying close attention to the appropriate level of risk for your portfolio. Our focus is to uncover those relative areas of value within asset classes and sectors so that we can continue to build your capital and help you realise your financial objectives.