We maintained our long-standing preference for equities over bonds as we entered 2019, despite the heavy sell-off in equity markets during the fourth quarter of 2018. This was based on the view that despite the global economy suffering from growing pains due to the Federal Reserve tightening monetary policy, equity valuations had become less demanding and global equities were trading at a lower earnings multiple than when markets last wobbled in early 2016. We felt that equities could recover from their oversold levels but noted that risks to this scenario had increased. Looking back now, our approach has been vindicated.
Global equities continued their strong run into the fourth quarter of 2019, leading to a return of 27% for the MSCI All Countries World for the year in 2019, its best performance since 2009. Markets were driven higher, as central banks cut interest rates to kick-start the economic recovery in the last few months of the year. This accommodative policy more than offset the drag from tit-for-tat US-China trade tariffs, which led to slower company earnings growth over the course of 2019. On a longer-term horizon, the US equity bull market is now into a record 10th year and has outperformed all other major stock markets and assets classes. That raises the bar for US stocks to continue to outperform on a relative basis. In Europe, despite economic stagnation and an industrial recession gripping Germany, MSCI Europe ex UK delivered total returns of 27.5% for the year. Although faced with domestic uncertainty, the FTSE 100 also generated a 17.3% return in 2019, buoyed most of the year by a weak pound and more recently by a re-rating of cheaper, domestic stocks.
2019 has also generally been a good year for fixed income, despite a poor fourth quarter, driven by monetary policy easing and investors’ search for yield at the lower quality end of the market. US Treasuries returned 7.4% over the year, spurred on by three Federal Reserve rate cuts that helped to push 10-year Treasury yields briefly below 1.5%. Lower quality high-yield US corporate bonds which yielded, on average, nearly 4% more than government bonds, looked attractive to investors and went on to return 14.7%. In the UK, gilts provided a return of 7.1%. The Conservative victory in the UK general election had little impact on the market, given the new government’s constrained fiscal expansion plans, relative to that proposed by the Labour party.
Against this backdrop, our overweight to equities was, unsurprisingly, a boost to relative performance and all geographic regions contributed positively. The only dampener was a lack of duration in our corporate and sovereign bond allocations, although part of this was offset by another strong showing from our alternative asset allocation. Overall, the relative performance of the six portfolios was pleasingly positive, and we outperformed each benchmark by between 1.29% and 3.91% in 2019, with the outperformance generally increasing with the rising risk profiles. Turnover was again low, with only four rebalances of the portfolios conducted during the year; one of these (December) was driven by changes in the Distribution Technology asset allocation frameworks.
We were surprised by the strength of the bond markets over the course of the year, their fourth quarter sell-off notwithstanding. Once again, our allocations within the portfolios were mostly in shorter-dated and index-linked government bonds, with a significant underweight to corporate bonds, which did not help. However, our positions in international bonds, namely M&G Emerging Markets Bond Fund (which we had increased exposure to in the fourth quarter of 2018) and iShares USD Corporate Bond ETF stood out, delivering double-digit returns. Within our bond holdings, the most significant trades were to exit Kames Investment Grade and, just before year end, to sell iShares USD Corporate Bond ETF as we sought to reduce our dollar exposure. The proceeds from the latter were switched into SSGA SPDR Barclays Global Aggregate Bond ETF.
There was, for the second year running, a strong showing from our alternative assets, with all three of our key holdings contributing significantly. Perhaps unsurprisingly our property exposure rallied strongly into and beyond the general election; UK Commercial Property REIT returned 11.3% and Picton Property Income 18.3% in 2019. BH Macro followed its stellar performance in 2018 with a return of over 10% as its discount to net asset value disappeared, and its shares traded at a consistent premium. We feel that the market has finally cottoned-on to what we have known for some time; that funds with a historical record of delivering in tougher times for risk assets are few and far between, and they will likely be sought out when bouts of volatility occur. We are more than happy to maintain our exposure to the fund which has proven its worth as portfolio insurance.
The year saw a very satisfactory return to form for our UK equity funds after a tough 2018. The only disappointment was RWC Enhanced Income (which still made positive ground); not unexpected and forgivable given that it was the only one to make positive ground in 2018. Artemis UK Select, MAN GLG Undervalued Assets, Investec UK Alpha and Troy Income & Growth Trust were all well ahead of the broader market. They were helped by a rotation in market leadership away from the big dollar earning companies which had previously done so well, driven by fears of a hard Brexit and a Corbyn government lurking in the background. The most significant change within the UK equity allocation during the year was the sale of Janus Henderson UK Absolute Return which was switched into Liontrust Special Situations as we looked to increase our sensitivity to the equity market as our outlook became more positive. For the second year running, some profits were also taken from BlackRock Smaller Companies as its shares moved to a premium to net asset value.
In overseas developed equity markets, our overweight to the US continued to help, but it was easily matched by the performance of our European and Japanese funds which were comfortably ahead of their benchmarks, MAN GLG Japan Core Alpha excepted. The stand-out performances for 2019 came from BlackRock European Dynamic (+30.1%) and JP Morgan Japan (+25.1%) demonstrating that good market performance and good economic performance are very often not correlated at all.
Asia and Emerging Markets were relative laggards again, but still produced double-digit returns for investors. As with last year, with such a diverse array of economies and drivers, performance from our list of holdings was varied, although all made positive ground. India and Frontier Markets were the notable laggards, but we remain happy to maintain our allocations here for diversification reasons, and because we believe in the long-term stories. Perhaps surprisingly to many, in a year where escalating trade tensions between the US and China dominated the headlines, our position in Fidelity China Special Situations rose by over 24%. This however, was not our most successful holding. Pictet Russian Equities followed a very strong year in 2018 with another in 2019, delivering over 34%. The Russian story remains compelling, and we are excited by the prospects for this well-managed, good governance-focused fund over the next couple of years. Our most significant trade within this portion of the portfolio was the introduction of BlackRock Emerging Markets Equity Strategies at the expense of Fidelity Emerging Markets.
Looking forward to 2020, we see clearing macro clouds, with an outline US-China trade agreement now possible. It probably doesn’t make sense for President Trump to escalate the US-China trade spat given that doing so will likely hinder output and jobs growth, and thus risk his re-election bid. Moreover, globally, monetary and fiscal policy is increasingly being used to support economic growth. Our base-case scenario of faster global growth in 2020 increases the probability that companies can deliver on earnings expectations. Not only should this raise risk appetite, but it also adds clarity on the market outlook. Outside of the US, the UK is perhaps the standout opportunity for 2020 in our view. The new Tory government should be free to concentrate on delivering low tax rates and deregulation to provide a business-friendly environment for companies to operate within. Over time, we expect current cheap UK equity valuations (and particularly those of domestically focused stocks) to mean revert and drive up equity prices in the process. We therefore retain our preference for equities over fixed interest for the time being, albeit remaining conscious that several warning signals are beginning to flash amber, and that a level of caution is merited.
Source: Thomson Reuters Datastream and Bloomberg. All values and charts as at 31 December 2019. Total returns in sterling. Based on market views at 31 December 2019
Please see below a table of performance for one and five years
|1 Year||5 Years|
|S&W MPS Defensive Portfolio||10.77%||34.53%|
|IA 0-35% Shares||8.8%||21.38%|
|S&W MPS Defensive Income Portfolio||12.96%||39.23%|
|IA 20-60% Shares||12.07%||27.95%|
|S&W MPS Balanced Income Portfolio||15.6%||47.39%|
|IA 40-85% Shares||15.94%||39.61%|
|S&W MPS Balanced Growth Portfolio||17.96%||55.74%|
|IA 40-85% Shares||15.94%||39.61%|
|S&W MPS Growth Portfolio||19.33%||61.46%|
|S&W MPS Dynamic Growth Portfolio||19.9%||65.64%|
Table source: Smith & Williamson (S&W) Investment Management (unaudited) / FactSet and IA (Investment Association) as at 31.12.19.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.
This article was previously published on Smith & Williamson prior to the launch of Evelyn Partners.