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Our market performance update
For March 2022 1. Commodities and Property strongest MTD 2. US & Global equities outperform UK 3. Liquid Real Assets outperforms Gilts For 1q22 Top performing asset class exposures in GBP terms: Commodities were strongest at +30.04% Gold & Precious Metals +10.04% UK Equity Income +6.06% All in GBP terms For more information, see attached pdf  [5 min read, open as pdf]
In a recent CPD webinar, Elston’s Henry Cobbe interviewed Patrick Minford, Professor of Applied Economics at Cardiff University and economic adviser to Margaret Thatcher in the late 1970s and early 1980s to ask about the fight with inflation in the 1970s and any comparisons for today. While it is tempting to look for similarities with the energy shock and period of sustained inflation that the UK suffered in the late 1970s and early 1980s, Professor Minford highlighted some significant differences. The lower risk of a wage-price spiral, central bank independence and a track record of manging inflation means lower risk of inflation getting out of control in the long-term. But the short- to medium-term remains under pressure. In Minford’s opinion, the risk to the growth is the bigger risk: and this would be the right time for HM Treasury to worry less about debt ratios, and turn on Government spending taps. Read full article, open as pdf Watch the CPD webinar (50mins)  [5 min read, open as pdf]
Rising inflation and rising interest rates, means nominal bonds (such as corporate bonds, UK gilts, and global government bonds) are under pressure, and will remain so for the medium-term. For so long as real yields remain negative, bonds are “guaranteed” to lose capital value in real terms over time. So what are the Alternatives to Bonds in a portfolio for UK investors? We explore the options within this article open as pdf or full version  [5 min read, open as pdf]
Some 18 year olds will have their Child Trust Fund maturing. Depending on how their parents had invested it, that could mean a lot or a little start to adult life. Our Head of Research, Henry Cobbe, provides some suggestions as regards next steps for an 18 year old with £29,000 to invest First of all – I’m sure you’ve done a big thank you to your parents for having set up, and topped up your CTF to grow it thus far! Everyone had the same starting point with CTFs, but it’s the decisions that your parents made that has determined your portfolio thus far. You should ask your parents’ adviser to help you get started, but if you really want to manage your own portfolio for now, rather than take advice, I would encourage you to make a straightforward three-step plan. 1. Choose your platform Firstly, decide on a platform. Interactive Investor’s flat-fee account is great for much larger pots, but your pot size means it’s much of a muchness between them and the other well-capitalised providers like Fidelity, AJ Bell and Hargreaves Lansdown. For a detailed analysis of platform fees, take a look at comparefundplatforms.com Using their tool, and assuming £29,000 lump sum ISA, £50 per month top up into 2 funds and no switches (buy and hold!), a like for like comparison suggests Interactive Investor 0.32% annual fees, AJBell 0.35%, Fidelity 0.35% and Hargreaves Lansdown 0.45%. Take a look at each website, decide which you find to be most helpful, and easiest to navigate. Customer service is important too, so try calling their helpdesks and see you find most helpful! 2. Choose your funds Secondly, decide on which funds, if you have a specific amount that you would ear-mark for the property deposit, and you expect that it’s in ten years’ time, you could consider using a target date fund, like Vanguard Target Retirement 2030 Fund Acc (0.24% OCF) or Vanguard Target Retirement 2035 Fund Acc (0.24% OCF) for that portion and ear mark that as your “deposit pot”. This means that as you get towards the target date, the investment strategy becomes less risky. That way the pot earmarked for your deposit is less exposed to a market shock if there is one in the run-up to you wanting withdraw funds for your deposit. For the remainder of your pot, as you’re lucky enough to have youth on your side, you have what’s called high “capacity for risk” in economic terms (not related to your behavioural/emotional “attitude to risk”), so can afford to take risk for long-term investments as the necessary flipside of returns. So for the remainder have a look at low cost global equity index funds such as:
3. Keep topping up Finally – and most importantly – heed the words of Warren Buffet in his advice to retail investors: “keep topping up through thick and thin, and especially through the thin”. The minimum fund subscription is £25 per month, so set up a regular investment plan into your chosen funds. The power of tax-free compounding is a marvel to behold. If markets have a wobble and you have spare cash, that can be a great time to top up with whatever you can afford. Lump sum or phased in? Markets are quite volatile at the moment so once you’ve got the money into your ISA, make a plan to invest into your chosen funds proportionally in say three or four stages over the rest of the year. That way you are “averaging in” to the market, rather than either getting very lucky (buying at a market low), or very unlucky (buying at a market high). Whilst in the long-run (say 30 years) it won’t matter (according to academia), it does make a difference to how you feel about taking the plunge, and can help remove a lot of worry. Set a date for review Make a plan as to when you will check in to your account – monthly, quarterly or annually. You would also need to rethink your strategy if your situation changes, or if your goals change. Whilst young and care-free you are probably right in your analysis that you may not need an adviser at this stage. But also put a date in your diary to speak to one when you’re any or all of 30, in a marriage/civil partnership, or starting a family. A good financial planner will review your situation and make sure that you have all the right things in place: mortgage, will, insurance, consolidated pensions, making the most of tax allowances and a broader plan to achieve your medium and long-term financial goals, whilst squaring off key financial risks. Good luck with the start of your investing journey! Notice: Not a personal recommendation. No assessment of suitability. Personal opinions expressed do not reflect the views of the author’s employer. Self-directed investors should read the terms and conditions and risk warnings of their selected platform, together with the KIID of any fund they select.  [5 min read, open as pdf]
Nominal bonds suffer in an inflationary regime. Real assets provide resilience in an inflationary regime, but have higher volatility. Our Liquid Real Assets index combines rate-sensitive assets and inflation-sensitive assets to capture real asset return patterns, with bond-like volatility. Underlying exposures to Gold, Energy, Precious Metals, Agriculture and Industrial Metals have all driven performance of the index year-to-date. The Liquid Real Assets index has outperformed gilts by 8.91ppt with similar risk characteristics. Portfolio managers and advisers who are looking to 1) reduce or remove nominal bond exposure, 2) want real asset exposure for inflation protection, and 3) want to maintain volatility budget can consider a lower-risk real assets strategy as an alternative. For full article with charts, open as pdf  [5 min read, open as pdf]
Even before the Russia/Ukraine war and sanctions, Covid policy stimulus, rapidity of the post-Covid restart, supply-chain disruptions and the energy crisis have stoked up inflationary pressure and we are in for a bumpy ride. While we are not yet past the peak, it takes years, not months, to tame inflation, so it makes sense to adapt portfolios for an inflationary regime. To understand asset class behaviour there is not much use looking at the last 10 or 20 years. That era has been characterised by falling interest rates and low inflation. Instead we have to go back to the history books and understand how asset classes behaved in the 1970s inflation shock and the subsequent period of rising interest rates and rising inflation. From studying academic research on that era, we draw three key conclusions: firstly, inflation protection can be achieved by owning the assets that benefit, rather than suffer, from inflation. Secondly, that different asset classes have different inflation-protective qualities over time. Finally, that liquidity is key so that there is flexibility to alter and adjust your portfolio. Equities: the long-term inflation hedge Equities provide the ultimate “long-term” inflation hedge – companies that make things that you always need and have pricing power can keep pace with or beat inflation. Within equities, studies show that a bias towards value, away from growth, outperforms during an inflationary regime. This is because of something known as “equity duration”, which basically means that companies that deliver earnings and dividends on a “jam today” basis, are more valuable than companies that are expected to deliver earnings and dividends in the very distant future on a “jam tomorrow” basis. You can access a Value ETF very simply by using factor-based ETFs, such as IWFV (iShares Edge MSCI World Value Factor UCITS ETF). But given that investors are likely to have equities in their portfolios already and therefore have long-term protection in place, how do you achieve inflation-protection for the bumpy ride over the short- and medium-term? Owning the problem Inflation-hedging can be described as “owning the problem”. Worried about rising oil, gas and petrol prices? Own an Energy ETP like AIGE (WisdomTree Energy ETP). Worried about rising wheat prices? Own an Agriculture ETP like AIGA (WisdomTree Agriculture ETP). Worried about rising rail-fares? Own an infrastructure ETF like GIN (SPDR Morningstar Multi-Asset Global Infrastructure UCITS ETF). Worried about rising rents? Own a property ETF like IWDP (iShares Developed Markets Property Yield UCITS ETF). Worried about rising household bills? Own a Utilities ETF like UTIW (Lyxor MSCI World Utilities TR UCITS ETF). By owning the assets that benefit, rather than suffer, from inflation, you can incorporate inflation-protection into your portfolio. These assets are referred to as “liquid real assets” as their value is positively related to inflation. They can be accessed in liquid format by using exchange traded products (ETPs) keeping your portfolio flexible to enable future adjustments as time goes on. Interestingly, real assets respond to inflation in different ways over different time frames. The study from the 1970s looked at the correlation of asset classes over time from the start of an inflation shock. It found that Commodities provided near-term inflation protection for the initial five or so years of inflation shock, but then moderated as supply-side solutions came-through. Infrastructure and Property provided medium- to long-term inflation protection but were vulnerable in the near-term to rising market risk associated with the break-out of inflation. Inflation-linked bonds – as the name suggests – provide inflation protection, if held to maturity. But in the short-term they can decline materially, as they are highly sensitive to increases in interest rates which are typically associated with inflation-fighting central bank policy. So while inflation-linked bonds like INXG (iShares GBP Index-Linked Gilts UCITS ETF) reduce inflation risk, they increase interest rate risk. By introducing some interest-rate hedging by owning assets whose interest rates go up when the Fed raises rates, like with FLOS (iShares USD Floating Rate Bond UCITS ETF GBP Hedged), this can be mitigated. Gold Gold is also a traditional real asset inflation-hedge: it preserves its value (purchasing power) over millennia, and is a classic “risk off” asset that can help protect a portfolio in times of market stress. Some critics of holding physical gold argue that is produces no income and therefore has no intrinsic value or growth. That may be so, but imagine you were a time-traveller – it’s the only money that you could use in any era going back to biblical times. It holds its value in inflationary and even in hyperinflationary times. From a portfolio perspective, it always makes sense to have some exposure both as a real asset, a shock-absorber and as an uncorrelated diversifier. Physical gold tends to outperform gold miners, in the long-run, and can be accessed at lower cost. There are plenty of low-cost physical gold ETPs to choose from. Bringing it all together We believe that a layered approach to inflation-hedging makes sense because of the different inflation-protection qualities of different asset classes over time. Within equities this means pivoting equity exposure towards a Value/Income bias. Within bonds, this means reducing duration and/or substituting nominal bonds with liquid real assets exposure as a potential alternative (subject to relevant risk controls). We have incorporated a range of higher risk inflation-protective asset classes, such as commodities, gold, infrastructure and property, medium-risk like lower duration inflation-linked bonds and lower risk rate-sensitive assets, such as floating rate notes to create a diversified Liquid Real Assets Index strategy that aims to deliver exposure to inflation-protective asset classes, while delivering an overall portfolio volatility similar to Gilts. This makes the strategy a potential alternative to traditional (nominal) bonds exposure that will continue to struggle in an inflationary regime. Summary For those wishing to isolate and target specific inflation-protective exposures, there is no shortage of choice for highly targeted inflation-hedging strategies. Adapting portfolios for inflation is key to ensure resilience in an inflationary regime. And while it may feel a bit late to get started, it’s better late than never. Find out more about our All-Weather Portfolio of ETFs for UK investors. Find out more about our Permanent Portfolio of ETFs for UK investors. See all our Research Portfolios  [5 min read, open as pdf]
Find out more on this topic in our upcoing CPD webinar
For investors with long time horizons who want an all-equity portfolio, there is no shortage of low- cost global equity ETFs. In cricketing terms, when sunshine’s guaranteed, a grass pitch works just fine. But when time horizons are shorter and risk control matters more – as in these uncertain times - a multi-asset approach might make better sense. Put differently, when the weather is changeable or extreme, an all-weather pitch makes more sense. It’s the same for investments. In these times of market volatility, rising interest rates and inflation pressure, we explore three different types of multi-asset strategy: the 60/40 portfolio, the “Equal Risk” or all-weather portfolio, and the “Equal Weight” or Permanent Portfolio. The problem with 60/40 The traditional multi-asset portfolio is the so-called “60/40” portfolio – where 60% is invested in equities, and 40% is invested in bonds. This is the “classic” multi-asset strategy. The idea being that you can combine higher risk and return from equities with lower risk income from bonds. A 60/40 portfolio can be constructed with just two ETFs. 60% in a global equity ETF like SSAC (iShares MSCI ACWI UCITS ETF) or VWRP (Vanguard FTSE All-World UCITS ETF); and 40% in a bond ETF – for example AGBP (iShares Core Global Aggregate Bond UCITS ETF GBP hedged) for those wanting global bond (hedged to GBP) exposure, or IGLT (iShares Core UK Gilts UCITS ETF) for those wanting UK government bond exposure. Or you can make it more and more granular. But this traditional 60/40 model is under pressure, and the suggestion currently is that the 60/40 portfolio is now “dead”. Why is this? Well because for the last 30 years or so, we’ve lived in a world where inflation and interest rates have been trending down – which is doubly good for bonds. But now we are now in an economic regime where both interest rates and inflation are starting to trend up – which is doubly bad for bonds. The other problem with 60/40, is that in times of market stress, the correlation between equities and bonds increases, meaning that bonds lack the diversifying power they may have had in the historical long-run, at a time when it is needed most. In summary: the advantage of this approach a 60/40 portfolio is easy to construct, and is a classic “balanced” portfolio. The disadvantage of this approach is that bonds are facing an uphill struggle for the next few years, so may not be as “balanced” as you would want. The all-weather portfolio The all-weather portfolio concept is that of a multi-asset portfolio that is designed to deliver resilient, consistent performance in different market regimes, or “whatever the weather”. The term and idea was pioneered by Ray Dalio of Bridgewater Associates (which was established in 1974, shortly after Nixon took the US Dollar off the gold standard) and is designed to answer the question: “What kind of investment portfolio would you hold that would perform well across all environments, be it a devaluation or something completely different?”[1]. Dalio and Bridgewater’s all-weather portfolio assumes equal odds of any of four market regimes (rising/falling growth/inflation) prevailing at any time. This approach created and pioneered what is also referred to as a “Risk Parity” approach to investing. The concept of risk parity requires some additional explanation. A classic 60/40 equity/bond allocation results in a portfolio where over 95% of overall portfolio risk comes from the equity position, and the balance comes from the bond position. In short, the asset allocation drives portfolio risk, and while a portfolio may be balanced in terms of asset allocation, it is imbalanced in terms of risk allocation. Risk parity reverses the maths: it means that each asset class contributes equally to the overall risk of a portfolio. This is why it is also known as an “Equal Risk” approach. But as risk is dynamic, not stable, the asset weights must adapt to keep the risk allocation stable. UK investors can build their own all-weather portfolio using four to six ETFs representing broad asset classes: global equities, UK equities, gilts, property, gold and cash equivalent, depending on complexity. In order to keep the risk allocation stable, the asset weights might need to change each month to reflect the changing risk and correlation relationships of and between those asset classes. In summary: the advantage of this Equal Risk approach is that a portfolio is truly diversified from a risk contribution perspective. The disadvantage of this approach is it requires a regular change of weights to reflect changing short-term volatilities and correlations. The Permanent Portfolio The permanent portfolio is a concept pioneered by the late Harry Browne, a US financial adviser, in his 1999 book “Fail-Safe Investing”. It has many adherents in both the US and the UK, but to date it is only really in the US that one can find ‘Permanent Portfolios’ on offer, something UK investors seem keen to change. The concept is similar to the all-weather portfolio, but in a more straightforward format. Rather than trying to target an “Equal Risk” contribution with changing asset-class weights, the Permanent Portfolio is a simple Equal Weight approach to four main asset classes to reflect different market regimes, so that whatever the regime, the portfolio has got it covered. Browne outlines four market regimes[2], and related asset exposure for that regime:
US versions of this strategy use US equities for the equity exposure and US treasuries for the bond exposure. So what would a UK version look like? We constructed a Permanent Portfolio for UK investors using 4 London listed ETFs: SSAC for global equities, IGLT for UK bonds, SGLN (iShares Physical Gold ETC) for gold and ERNS (iShares GBP Ultrashort Bond UCITS ETF) for cash equivalents for some additional yield over cash that will capture rising interest rates. In summary: the advantage of this Equal Weight approach is its simplicity and low-level of maintenance required. The disadvantage of this approach is that it disregards short-run changes in volatility and correlation that are captured in the Equal Risk approach. How do they all compare? Obviously the strategies vary from each other. To evaluate performance, we have created research portfolios for both these strategies. What becomes apparent is that the outperformance of these low-cost, equal-risk and equal-weight all-weather and permanent portfolios looks relatively attractive when set against many more complex (and expensive) “all-weather” absolute return funds. Find out more about our All-Weather Portfolio of ETFs for UK investors. Find out more about our Permanent Portfolio of ETFs for UK investors. See all our Research Portfolios Attend our CPD webinar on this topic [1] https://www.bridgewater.com/research-and-insights/the-all-weather-story [2] Harry Browne, Fail-Safe Investing, (1999) Rule #11 Build a bullet-proof portfolio for protection (pp.38-49)  [5 min read, open as pdf]
The “great rotation” to Value began towards the end of 2020 as inflation fears came into focus. It has been rewarded. Since Dec 2020, the MSCI World Value factor has delivered +21.43% returns to 25th February 2022 compared to +7.70% return for Growth factor and +14.78% for the parent MSCI World index (a traditional market-cap based index), all in GBP terms. If we look back further at relative performance since end 2007 to 25-Feb-22, we can see that Value’s underperformance relative to Growth is still material. Over that period, Growth returned +369% (11.54%pa), compared to +179% (7.52%pa) for Value, and +268% (9.63%pa) for traditional market-cap based world equities, in GBP terms. On this basis, the re-rating of Value, relative to Growth, has room to run in the face of a persistent inflationary regime. Read full article with charts Watch our CISI-accredited CPD on an Introduction to Factor Investing  [1 min read, open as pdf]
We take a brief look at the performance update for our Liquid Real Assets Index. Exposure to Energy and broader commodities, as well as Gold & Precious Metals is supporting performance. The strategy is keeping pace with inflation, and outperforming gilts in the long-run and year-to-date, with similar level of volatility. Gilts are now underperforming inflation since index inception (Dec-17). Full updates are provided quarterly. 
Whereas there is no shortage of analysis on the risk and return of active and index-tracking funds alike, there is less detailed analysis on liquidity risk. Liquidity risk is a key aspect of Product Governance for advisers, and liquidity problems have been the underlying reasons for gatings (the suspension of client dealings) of high-profile funds in equity, bond and property asset-classes. We explore the importance of liquidity in fund selection, and considerations when contrasting formats, strategies and evaluation metrics. For retail investors, access and liquidity are essential. We strongly believe that when building portfolios for retail investors, there should be a strong preference towards highly liquid funds, so that – simply – investors can get their money back if they need it. This is why in portfolios we designed for wealth managers and advisers in 2016, we advocated to use property security ETFs, rather than property funds, which was subsequently vindicated by the Brexit-related gatings in 2016 and 2020. This is why we advocated – in 2019 – that investors were concerned about bond liquidity, they should stick to Bond ETFs. This was based on insights we learned from the yield spike in 2017 that saw liquidity in high-yield bonds dry up, and highlighted the same issues as property funds faced. This is why we advocated – in 2020 – that when constructing alternative asset class exposures within portfolios, advisers would be safest to stick with liquid versions of those alternative asset exposures. And finally, this is why, when it comes to looking at active equity funds, we study the liquidity profile (redemption horizon) so carefully. We want to help advisers we work with to “avoid” the next Woodford – not just from a performance perspective, but from a liquidity perspective too. As we move from an era of accommodative liquidity (quantitative easing) to a gradual reduction in liquidity (quantitative tightening), understanding the liquidity profile of funds and portfolios is key. This is more than a box tick for product governance. It is an essential protection of client best interests. Register you interest in receiving our liquidity analysis white-paper (for UK advisers only) Register for our CPD webinar on Liquidty Risk and Fund Selection  [3 min read, open as pdf]
Monthly update Commodities was the top performing asset class in February, returning +6.83% in GBP terms, on inflation fears and energy crisis- exacerbated by political risk resulting from Russia’s invasion of Ukraine. Fears of the first European land war since the 1990s also drove demand for Gold as a safe-haven asset and inflation hedge. Our Gold & Precious Metals index – a composite of predominantly gold, but also silver, platinum and palladium – increased +5.65% MTD in GBP terms. Within equities, UK equities continued to outperform US and global equities owing to the inherent value bias. Our Liquid Real Assets index returned +1.21% for the month, compared to Gilts -1.44%. Within the multi-asset space, our “Equal Risk” or Risk Parity Index returned +0.27%, compared to -1.32% for a traditional 60/40 portfolio. US & UK 10 year yields closed at 1.87% and 1.42% respectively US & UK 5 year market-implied Break Even Inflation Rates closed at 3.19% and 4.52% respectively. Our granular asset-level report is updated in our Quarterly Review and Outlook after each March, June, September and December quarter end. Market performance The month-end market performance snapshot is summarised in the chart below. For latest commentary, please refer to our Insights and weekly Friday Insights email. |
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