Seeking the right equity strategy


It is fair to say last year proved to be challenging – particularly for investment trust investors. However, the year provided much to reflect on and perhaps threw up straws in the wind as to what the coming years may have in hand. Last month’s column focused on alternative assets and diversification. As we enter 2023, it is worth looking at equity positioning and some of the reasoning both by way of region and theme.

A challenging year

The performance statistics for the major indices paint only part of the picture. For example, the MSCI World (£) and the FTSE All-Share produced total returns of -7.83% and 0.34% respectively. Yet UK Conventional Gilts saw a return of -23.83% while the FTSE All-Share Closed-Ended (investment trust) Index returned -16.57% as discounts widened meaningfully – both helping to explain why more conventional defensively-positioned portfolios provided little relief. For example, the MSCI PIMFA Conservative benchmark returned -11.60%.

2022 also saw marked share price volatility as sentiment oscillated in reaction to challenging geo-political and economic news, including UK inflation (CPI) ending the year at 10.08%, which also helps to explain why many ‘growth’ companies had such a torrid year.

As regular readers know, investing for the long-term means you can often take contrarian positions – as such, short-term performance may vary from relevant benchmarks.

Equity positioning

Recent columns have highlighted concerns about the economic outlook and policymakers’ grasp of the situation both here and globally. I will not reiterate the reasoning. Last month’s column ‘Seeking the right balance’ focussed on the importance of recognising the more conventional and conservative 60/40 equity/bond portfolio was ill-equipped to achieve sufficient diversification in this new market regime, and suggested better alternatives.

These recent columns also help to explain why a range of alternative assets have played an important role alongside equities in recent years. Various headwinds including elevated levels of inflation and interest rates, sluggish economic growth, high debt and geo-political difficulties will continue to buffer markets. Equities usually embrace the early stages of inflation, but fail to produce real returns if it rises and remains high thereafter. Investors are less willing to pay up for future earnings and valuations tend to fall.

Higher discount rates are putting pressure on often lofty valuations. This will not subside any time soon given inflation will remain more elevated than consensus forecasts indicate. In contrast, ‘value’ companies should remain less susceptible as cheaper valuations are less impacted and higher dividend payouts are welcomed by investors given the increasing attractions of cash.

It’s important to remember that markets often embrace long cycles, and it’s equally important recognising when market regimes shift. Strategists too often refer to history when extrapolating the future – it can proffer ideas, but can only be of limited use in different market regimes. Further to recent columns suggesting the extent to which the investment landscape has indeed changed, investors should expect long swings now in favour of different assets – equity or otherwise.

The big gainer of the past decade was US equities, particularly the technology companies. Bonds were the big beneficiary of the past four decades. Though better value of late, these are unlikely to lead the way going forward for reasons previously highlighted. By contrast, the UK looks well-placed for reasons explained in the column ‘Trade of the decade?’ – sentiment continues to trail fundamentals and prospects. Sound outperformance of the global benchmarks last year, and a good start to this year, bode well.

In looking overseas, emerging markets are looking increasingly attractive. The MSCI Emerging Markets (EM) index has struggled over the last decade. Company returns have broadly matched those of developed markets, but share prices have been savaged – having de-rated from a comparable price/book value to now barely half. By many measures, the EM index is now at its cheapest since inception. Markets can stay cheap for long periods – oft-sought for catalysts which spark a re-rating can be frustratingly slow to arrive.

However, a number of tailwinds of varying speeds are now aligning which, cumulatively, may have the desired effect. Many countries now boast greater economic resilience – previously considered purely as a source of commodities and cheap labour, they have deeper pools of demand with domestic consumption nearly tripling over the last decade or so. Bigger currency reserves, a more proactive approach to looming inflation, a lesser dependency on the US$ and younger populations, are some of the reasons to be positive.

Meanwhile, Japan continues to look attractive relative to prospects. The gradual change in corporate governance, including greater reverence for shareholders and dividends, price to book valuations that remain exceedingly attractive, a market particularly shunned by international investors, and global leadership in certain sectors are some of the positives. Perhaps the advent of rising inflation and the nuanced change in the Bank of Japan’s policy will precipitate the long-awaited catalyst needed to spark a re-rating. Time will tell.

Portfolio balance should always be maintained. In addition to focusing on the right regions, investors will need to ensure adequate exposure to the long-term secular themes of the future – certainly when compared to the more traditional portfolio so beloved of the previous market regime. These include smaller technology companies, and the full spectrum of opportunities within the healthcare, private equity and climate change spaces.

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