Equity markets had a turbulent first quarter of 2018. The strong upward moment from the final quarter of last year continued in the first part of January, supported by encouraging news by economies and corporate earnings. However, markets then began to suffer a correction. It was first triggered by some fears of rising wage inflation and the implication that might have for interest rates. The weakness later accelerated on fears of a global trade war after Trump’s imposition of general tariffs on steel and aluminium followed by more specific tariffs on Chinese exports. The fall is the first significant setback for markets for well over a year. During which time, steady returns with low volatility were enjoyed.
Bonds, Property, and Stocks
Bonds generally fell over the quarter on those inflation and interest rate worries. Though more recently, they have recovered some of those falls due to fears that protectionism may reduce global growth. Property again made steady progress over the period. We believe the current setback in the stock market is a correction rather than an end to the bull markets and equities remain our preferred asset class.
We see a fairly healthy outlook for global GDP, strengthened corporate profits and a continuation of reasonably loose monetary conditions from the major central banks. At the same time, valuations are excessive and many of the worrying signs that tend to build up in the later stages of a bull market do not appear especially pronounced. The growing risks of protectionism, following Trumps announcements on tariffs, are a worry but at this stage we hope that there is a lot of posturing taking place and in time we shall see constructive discussions.
Equities over bonds
During Q1, the multi asset funds performed to strategic benchmarks. Positive factors, including the equity markets in Asia and Japan which performed relatively well and a positive approach to property which made solid gains. Stock selection in the equity portfolios also added value, especially in the UK, Europe and Japan. However, our tactical position favouring equities over bonds detracted value as markets corrected. But I’m please to say that equities have seen a useful recovery so far in Q2 and we’ve stuck with our positions.
Markets around the world
Our preferred markets are unchanged including Japan, Asia Pacific, and Europe. The UK is neutral and the valuation here is fairly attractive compared to other markets, especially the dividend yield. However, political risks and risks from Brexit are significant concerns. We’ve recently moved the US up to neutral reflecting the excellent corporate results being reported and the dominant position of many US companies on the global stage offering interesting investment opportunities.
We see bonds as relatively unattractive on valuation basis in comparison to other asset classes despite not anticipating significant rises in inflation nor material policy tightening by central banks. We’ve become a little more cautious on corporate bonds where spreads i.e. the incremental yields over government bonds have fallen to pretty low levels by historical standards.
We see further upside by UK commercial property. The attractive yield continues to appeal to retail investors and over sea buyers. At the same time, new supply remains limited apart from around Central London. Our portfolios have limited exposure to this area.
Changes made to Horizon funds
Since the start of the year, we’ve made some adjustments to our tactical asset allocation around the strategic benchmark for each funds. Early in the quarter, we took profits on equity positions, particularly in Asia and emerging markets, as equities continued to advance. At the same time, we topped up some bond holdings following some general rise in yields. Later in the period, after equities started their correction, we topped up some holdings in the lower levels. We also top sliced some positions in high yield corporate bonds where we see yield spreads over government bonds offering less compelling attractions than previously. We recently added to US equities.
As well as our tactical positioning, there are also quarterly updates to the strategic allocations. E-Value, the independent consultants, set the strategic asset allocations benchmarks for each managed fund based on their expectations for risks and returns. The Q2 strategic benchmarks change generally switched some money from UK gilts to UK corporate bonds and slightly increased UK equity exposure at the expense of overseas markets. The exception was Zurich Horizon Multi Asset Fund I, which diversified further away UK equities following the decision to allow overseas holdings taken earlier this year.
We believe the combination of E-Value strategic allocation and our tactical positions present an attractive mix of investments for your clients in current markets where volatility has risen in recent years.
Alex Lyle is an Investment Manager at Columbia Threadneedle and the manager of the Zurich Horizon Multi Asset Funds.