 [5 min read, open as pdf]
Interest rates expected to rise As the run up in inflation looks more persistent, than transitory, there is growing likelihood that Central Banks will raise interest rates in response. Following an extended “lower for longer” near-Zero Interest Rate Policy following the 2008 Global Financial Crisis and the 2020 COVID Crisis, the market futures-implied expectations for the Fed Funds rate, points to a “take off” in 2022 in response to rising inflation, following COVID-related policy support, to an expected 1.01% interest rate level in Dec-23[1], from 0.88% last quarter. Fig.1. Fed Funds Rate and implied expectations  Source: Elston research, Bloomberg data
The potential for increased interest rate volatility, as rate hike expectations increase, means that investors that are seeking to dampen interest rate sensitivity (“duration”) are allocating to shorter-duration exposures, such as ultrashort-duration bonds, and also to Floating Rate Notes (FRNs). What is a Floating Rate Note? Floating Rate Notes receive interest payments that are directly linked to changes in near-term interest rates and can therefore provide a degree of protection against interest rate risk, when interest rates are rising. Issued for the most part by corporations, FRNs pay a periodic coupon – typically quarterly – that resets periodically in line with short-term interest rates. This could be expressed as a premium or “spread” over a currency’s short-term risk-free rate, such as (in the UK) the 3 month SONIA rate (Sterling Overnight Index Average, and prior to that GBP LIBOR) in the UK, or (in the US) the 3 month SOFR (Secured Overnight Funding Rate, and prior to that USD LIBOR). These indices overnight borrowing rates between financial institutions. The size of the premium or spread reflects the creditworthiness of the issuer: the higher the spread, the greater the rewarded risk for owning that security, and typically stays the same for the life of the bond and is based on the issuer’s credit risk as deemed by the market. How can FRNs benefit investors? Floating Rate Notes are a lower-risk way of putting cash to work and provide a useful direct hedge against interest rate fluctuations. When incorporated into a bond portfolio, they can help bring down duration given their reduced sensitivity to interest rate changes, as well as provide a return pattern that is directly and positively correlated with changes in interest rates. Compared to nominal bonds, such as Corporate Bonds and UK Gilts, FRNs’ yield can increase as/when interest rates increase. Relative to money market funds, FRNs may provide some additional yield pick-up, as well as very short <1 year duration. Key considerations when investing in FRNs Portfolio investors can access FRNs through funds and ETFs. Key considerations when investing in FRNs include, but are not limited to:
Summary The expected timing of interest rate “lift off” in the US and UK will change as markets adapt to evolving growth and inflation outlook during the post-COVID recovery, and in response to the risk of further disruption from new virus variants. However, as interest rate rises become more likely, and incorporating an allocation to Floating Rate Notes for protection against interest rate risk makes sense within the bond allocation. Watch the CPD Webinar: The Quest for Yield [1] Data as at last quarter end
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Inflation on the rise With inflation on the rise – and potentially interest rates too – nominal bonds are likely to remain under pressure. Whilst “real assets” – such as property, infrastructure and gold – have potential to preserve value in inflationary regimes, how can a switch from bonds to real assets be made without materially up-risking portfolios? This was the challenge we addressed in the design of our Liquid Real Assets index. Our Liquid Real Assets Index was developed to combine exposure to higher risk-return real asset exposures, with lower risk-return interest rate-sensitive assets, to deliver a real asset return exposure for inflation protection, in liquid format, with bond-like volatility to keep risk budgets in check. Given the rising inflationary pressures both in the US (where in Oct-21 it crossed 6%, the highest level in 30 years) and in the UK (where in Oct-21 it crossed 4%, the highest level in a decade), we take stock on the index performance year-to-date and are glad to say it’s “doing what it says on the tin. [Read full article] [Watch the webinar]  [3 min read, open as pdf]
Ahead of estimates UK CPI print for October came in at 4.2%yy vs 3.9% estimate and 3.1%yy in September. Inflation rates were higher than expected and the highest in a decade, putting more pressure on the Bank of England to raise interest rates and creating a palpable squeeze on cost of living for households through the winter. The increase was driven by energy prices and the impact of supply shortages across the economy. 
Inflation is proving more persistent than transitory. In an inflationary environment, Value style investing has the potential for continued outperformance relative to other factors. For UK fund investors, actively managed funds with a value-oriented philosophy, UK equity income funds with an inherent value bias and Value-factor index funds/ETFs offer ways of increasing allocation to Value within a portfolio. Read the article (5 min read) Watch the webinar 
Ahead of estimates, again US CPI print for October came in at 6.2%yy vs 5.9% estimate and 5.4%yy in September. Higher prices for energy, accommodation, food and vehicles drove the October print and suggested that inflation pressure is broadening out beyond just the “reopening” sectors. Get the full report Visit our Liquid Real Assets page  Register for the webinar/View the replay Read the full article
What is the 60/40 portfolio? Trying to find the very first mention of a 60/40 portfolio is a challenge, but it links back to Markowitz Modern Portfolio Theory and was for many years seen as close to the optimal allocation between [US] equities and [US] bonds. Harry Markowitz himself when considering a “heuristic” rule of thumb talked of a 50/50 portfolio. But the notional 60/40 equity/bond portfolio has been a long-standing proxy for a balanced mandate, combining higher-risk-return growth assets with lower-risk-return income-generating assets. What’s in a 60/40? Obviously the nature of the equity and the nature of the bonds depend on the investor. US investors look at 60% US equities/40% US treasuries. Global investors might look at 60% Global Equities/40% Global Bonds. For UK investors – and our Elston 60/40 GBP Index – we look at 60% predominantly Global Equities and 40% predominantly UK bonds Why does it matter? In the same way as a Global Equities index is a useful benchmark for a “do-nothing” stock picker, the 60/40 portfolio is a useful benchmark for a “do-nothing” multi-asset investor. Multi-asset investors, with all their detailed decision making around asset allocation, risk management, hedging overlays and implementation options either do better than, or worse than this straightforward “do-nothing” approach of a regularly rebalanced 60/40 portfolio. Indeed – its simplicity is part of its appeal that enables investors to access a simple multi-asset strategy at low cost. The problem with bonds (the ‘40’) in an inflationary environment Over the years, the relationship between asset classes has changed so much that the validity of 60/40 as a strategy can legitimately be questioned. Read the full article or register for the webinar/View the replay 
The era of quantitative easing programmes have had a distorting effect on markets since the 2008 financial crisis has given value investors a torrid time in the past decade. The near-constant sugar-rush of liquidity has served to de-link valuations from underlying fundamentals prompting a huge bias towards growth. While pockets of investors have been braced for a long-expected correction that has never really materialised, the recent sharp increase in inflation may constitute an inflection point of sorts. In inflationary periods and when interest rates rise, the time horizon for future discounting shrinks, leaving equities exposed. Income-yielding shares have an inherent value-bias, owing to the types of company that pay steady dependable dividend). This provides a measure of inflation protection both in absolute terms and relative to nominal bonds. Read the full article Watch the webinar  [3 minute read]
Request the research paper Register for our CISI-accredited webinar with guest speakers from the World Gold Council Throughout recorded history, gold – rare and unreactive – has held its place as a coveted precious metal. Useful as both a store of value and as a means of exchange, in the modern era, gold has a core part to play in investor portfolios. Exposure to it offers investors three key benefits: insurance against shocks, risk-based diversification and – most significantly in our current environment - a hedge against inflation. The only free lunch in financial markets? The diversification effect is not only about adding an additional asset class, it is about an uncorrelated return pattern relative to both equities and bonds. Of all the precious metals and broader commodities traded, gold holds its own as the most powerful diversifier, exhibiting consistently low correlation with other major asset classes. Resistance to volatility Not only does gold outperform other commodities over time but it has also tended to perform positively when volatility increases. In periods of high inflation and currency devaluation, gold serves to protect investors’ purchasing power. Gold’s insurance characteristics mean that the optimal allocation for gold increases when risk in a portfolio increases. Current relevance In the ultra-low interest rate environment of today, increasing inflation fears means negative real yields, therefore the opportunity cost of holding non-income-generating assets is declining. While commodities provide near-term inflation protection particularly when related to supply shocks, gold has typically provided greater inflation protection characteristics during inflationary regimes, in part because the gold price reflects broader economic growth as defined by consumer price inflation and money supply. Not the only precious metal diversifier Gold is by no means alone in the precious metals category. Other key metals in the asset class include silver, platinum and palladium, each with characteristics of their own. All three carry significant value as industrial metals required in manufacturing of batteries, super-conductors and within the auto industry, rendering their prices more vulnerable to supply and demand fluctuations, and thus increased volatility. We explore the value they can offer and the role they can play within a portfolio. How to gain access as a retail investor? While professional investors can gain access to gold via the Futures market, what are the options available to UK advisers when constructing a retail client portfolio? From precious metal ETPs to funds of producers to simply buying and storing a bar of gold, we delve into the pros and cons, offering an unbiased overview of the opportunities available.  The rapid restart, supply chain disruption and scramble for gas is creating an inflationary Big Squeeze... whatever next and how to adapt? Whilst we would like to think inflation will be transitory rather than persistent, events are making that thinking look wishful. Our market update webinar will take stock of what's happening and why, and how to position portfolios from an asset allocation perspective.
To join the discussion on macro and market outlook, we are delighted to welcome Karim Chedid, CAIA, Director and Head of Investment Strategy for iShares EMEA. Agenda 1. What's driving "The Big Squeeze" - rapid restart, pent-up demand and supply shortfalls: how does this play out? 2. We assess the outlook against the "triangle" of growth, inflation and interest rates 3. We look at market regime, and portfolio resilience and vulnerabilities in an inflationary world Please join us on Wed 27 Oct at 1030am 
Read the article in full (5 min read) Following the post-COVID restart, there would necessarily be an inflationary spike, from base effects alone. Central Banks’ core thesis was that this spike would be “transitory”, rather than “persistent”. However, the combination of pent-up demand, supply chain disruptions and an energy crisis suggests that inflation could prove more persistent than transitory. We look at the numbers and how this informs the “big picture triangle” of three key macro factors: growth, inflation and interest rates. Finally, we outlined potential interventions in portfolio positioning from an asset allocation perspective. Nominal bonds are known to be structurally challenged in an inflationary regime, and propose real asset exposure instead. Within equities, we would propose an income/value bias. Regiser for our 3q21 Review & Outlook: The Big Squeeze  Money market funds, and their exchange-traded equivalents “ultra-short duration bond funds”[1], are an important, if unglamorous, tool in portfolio manager’s toolkit. They can be used in place of a cash holding for additional yield, without compromising on risk, liquidity or cost. Money market funds are intended to preserve capital and provide returns similar to those available on the wholesale money markets (e.g. the SONIA rate that replace LIBOR). How risky is a money market fund? Money market-type funds hold near-to maturity investment grade paper. Their weighted average term to maturity is <1 year. They therefore have very low effective duration (the sensitivity to changes in interest rates). Compare gilts which are seen as a low-risk asset relative to equities. The 10-11 year duration on UK gilts (all maturities) means they carry a higher level volatility compared to cash (which has nil volatility). On the flip side, their longer term also means they have higher risk-return potential relative to cash and ultra-short bonds. By contrast, money market type funds have some investment risk as they hold non-cash assets, but given their holdings’ investment grade status, short term to maturity and ultra-short effective duration, they exhibit near-nil volatility. Platform cash, fixed term deposit or money market fund From a flexibility perspective and a value for money perspective, there's a clear rationale to hold money market funds, rather than platform cash or a fixed term deposit. Our Money Markets fund research paper that looks at 4 low cost money market funds sets out why Why does the fund structure make sense? Find out more in our CPD Webinar on Introduction to Collective Investment Schemes  The illiquidity premium is the additional rewarded risk associated with holding an illiquid investment.
One of the attractions of private markets relative to public markets is the trade-off between enhanced returns and reduced liquidity, known as the “illiquidity premium”. Private market deals often require investors’ money to be “locked up” (i.e. non-realisable and cannot be withdrawn) for anything up to ten years. By way of compensation, investors’ should enjoy potentially much higher rates of return. In the chart, we contrast the long-term expected returns, and range of returns, for US private equity vs a proxy for public equity and US private debt vs a proxy for US corporate bonds. Whilst the potential for returns is clearly higher, the range of potential outcomes is much higher too, reflecting the higher risk-reward trade off. Contrasting public market and private market expected & variability of returns reflects their different characteristics, risks and opportunities. Request our Access to Private Markets white paper Register for our Introduction to Private Markets webinar  [7 min read, Open as pdf]
“A code red for humanity. The alarm bells are deafening and the evidence is irrefutable.” UN Secretary General Antonio Guterres discussing the most recent Inter-Governmental Panel on Climate Change (IPCC) report published in August 2021. For advisers looking to incorporate a Net Zero approach into a client portfolio, where ESG preferences are high, we would advocate a three-step approach. 1.Understand the Carbon footprint of your existing portfolio 2.Consider how substitutions of traditional with ESG-screened funds could reduce that Carbon footprint 3.Consider whether, and to what extent, an allocation towards climate solutions, which by their nature may be higher risk investments, will actively contribute to achieving the path to net zero. A bias towards ESG and a moderate investment in climate solutions, can help achieve those objectives for those clients who seek climate-oriented values in their investment portfolio, as well as their day-to-day living, For full article, Open as pdf  [3 min read, open as pdf]
US inflation moderates US CPI moderated from +5.4% to +5.3% y/y, whilst Core PCI (excluding energy and food) moderated from +4.3%yy to +4.0%yy. Full article in pdf  [3 min read]
Private markets exposure is growing in terms of both assets and popularity and offers potential for “true active” returns. We explore why and how advisers get access to this trend. Why private markets are in demand Private markets – incorporating private equity, private debt (direct lending), private real estate, unlisted infrastructure, unlisted natural resources – are characterised by attributes traditionally at odds with retail investing. Opacity, illiquidity, lengthy lock-up periods to name a few, and for that reason have largely been the domain of the institutional investor. But the growth in volume of private market strategies has become hard to ignore, as have the increasingly eye-watering returns enjoyed by private market managers. Overall private market AUM has increased from US$2.7tr in 2010 to US$7.2tr in 2020 and is expected to grow to US$12.9tr by 2025[1], with the majority of this in private equity. How can advisers access private market trends for their clients? In our white paper, we explore:
Request our Access to Private Markets white paper Register for our Introduction to Private Markets webinar [1] Preqin estimates, 2021  [3 min read, open as pdf]
The active vs passive debate is nothing new: the first index fund was launched in 1976 to track the S&P 500. In 1991, Nobel prize winner, William Sharpe (of Sharpe ratio fame), wrote a paper on “The Arithmetic of Active” setting out some of the clichés articulated by active managers, and why, in his view, it’s a zero sum game. Definition terms is key Whenever the active vs passive debate kicks off it’s always important to define terms. If referring to an asset allocation process, we prefer the terms static and dynamic and that’s got nothing to do with the subject of this paper or the claims by index investors that “active” is a zero sum game. Nor does the “activeness” or otherwise of hedge funds. The zero-sum game allegation relates to security selection, typically in a long-only context and therefore most relevant to managers of portfolios of securities and/or retail funds. What the Sharpe paper says Broadly speaking the Sharpe paper argues that in a closed world of active managers (stock pickers within an asset class), where the opportunity set is the index, for every “star” manager buying and holding the best performing stocks, there is a “dog” manager to whom the worst performing stocks have been sold. In aggregate, over time, this means the combined performance of both managers is the same as the index less active fees. This makes it hard for active managers to persistently outperform the index over time, which is evidenced by the SPIVA study. On this basis, using a fund that delivers performance of the index less passive fees seems like a more efficient way to gain exposure to that opportunity set. What are the implications for fund pickers The SPIVA study shows that the ability of active managers to outperform an index persistently varies from market to market depending on the efficiency of that market. For example, US and Global Equity markets fewer managers manage to outperform. For UK and Emerging Markets, active managers achieve better results. The latest SPIVA scorecard can be found here. We are not against “true active”, but the “arithmetic” is stacked against traditional long-only retail managers when it comes to persistency of alpha. Incorporating an index based approach where markets are highly efficient, and or where the availability of “true active” managers is rare. How to identify “true active” is a topic for another day! 
Last week, the US Senate passed a $1.2trillion infrastructure bill that now awaits a House vote as part of the "build back better" campaign, and another part of the "bazooka" post-COVID policy stimulus. Whilst there are plenty of infrastructure equity funds like INFR (iShares Global Infrastructure UCITS ETF) and WUTI (SPDR® MSCI World Utilities UCITS ETF) that benefit from infrastructure spend, for those not wanting to uprisk portfolio, we like GIN (SPDR® Morningstar Multi-Asset Global Infrastructure UCITS ETF) which invests in infrastructure equity and debt securities. Infrastructure & Utilities forms a core part of our Liquid Real Assets Index, for the inflation-protective qualities (tariff formulae typically pass through inflation). The "hybrid" nature of infrastructure - with both equity and bond like components is why we place it firmly in the Alternative Assets category. Helpfully this can be accessed in a highly iquid and (relatively) low-cost format, compared to higher cost, less transparent and potentially less liquid infrastructure funds. 
US inflation at highest level in 13 years running at +5.4%yy for second month, Core inflation (excl energy) +4.3%yy (Jul) from +4.5% (Jun). With a slight moderation in core inflation, economists are calling this as the inflation "peak". Whilst this may represent "peak inflation" year over year, overall inflation levels will remain elevated on restart and supply chain constraints As explored in our recent article on “catch-up” rates, we believe Fed policy will remain accommodative, with interest rates "lower for longer", as it lets inflation run "hotter for longer". This is positive for risk assets that offer inflation protection In inflationary regime we favour value-bias equities and real assets for diversification.  [3 min read, open as pdf]
The inflation theme is resonating in US earnings calls with company CEOs seeing this "temporary regime" lasting longer into 2022. In terms of prints, June CPI in the US was +5.4% and core CPI +4.5% - the highest print since November 1991. Markets have been caught between a push-pull between inflation data and interest rate policy response. Concerns that inflation is more persistent than transitory is driving flows to “risk on” assets. Related concerns that the Fed might start tightening policy earlier and sharper has been the “risk off” trade. Looking at inflation “catch-up” rates suggests that the Fed might let inflation run hotter for longer, pointing to a later lift off in rates from current low interest rates. This would be supportive for risk assets. What are “catch-up” rates? In 2020 ahead of the annual Jackson Hole conference the Fed indicated that it would take a more accommodative approach to inflation crossing the 2% target threshold. Why is this? Part of the answer is the concept of “catch up” rates. Essentially this means that a rate above 2% temporarily is ok if it means we are getting back to a 2% long-term trend-line. Effectively, letting inflation run hot and overshoot target in the short-term can make up for system slack/undershoots in prior years. What are the reference points? We don’t’ know the reference points (basis, trend-lines or catch-up period) the Fed will be using in its Policy decisions. So to illustrate this concept of “catch up rates”, we created an example with cumulative inflation (left hand scale) and average inflation rates (right hand scale). Our methodology We took December 2005 as a base, applied a cumulative 2% target inflation path (in blue), and then plotted cumulative path based on actual inflation rate (in green, averaging (dotted green line) 1.87%p.a. to June 2020 – i.e. below target rate). The red dashed line is the implied path back to trend-line assuming a “catch-up rate” of 2.65%p.a. (red-dotted line) that it would take for inflation to get back to the original trendline over 3 years. The catch up rate would be higher if using a shorter time-frame, and lower if using a longer-time frame. Conclusion Looking at implied three year “catch-up” rate helpso illustrate the concept and explains why Fed might let inflation run hotter for longer, pointing to a later lift off in rates. In inflationary regime we favour value-bias equities and real assets for diversification. Find out more in our quarterly review and outlook.  [10 min read, open as pdf]
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