Market Commentary February 2021

Major Equity markets rise again on sector rotation

Equities turned in another positive month across the major markets in February. Among the global market sectors, leadership moved from technology to financials, as investors switched their focus from growth to value. Banks performed especially well during the month. The rally in value stocks wrong-footed many active funds, which tend to invest primarily in growth stocks, as these are usually at the forefront of market rises.

Bond yields spark fears of rate rises

Bonds across the world suffered a very poor month, with yields rising in all sectors of the bond market. A continued recovery in oil prices, coupled with the ongoing vaccine roll-out and anticipation of the end of Covid restrictions led investors to sell bonds, which yield little or nothing (less than nothing in the case of some government bonds). As the 10y US Treasury yield reached 1.4%, equity markets were spooked, and saw increased volatility, as investors feared rate rises later in the year.

Sterling strength continues on recovery hopes/vaccine roll-out

The pound continued its rally against other major currencies, that started in the run-up to the Christmas Eve Brexit trade agreement. This was supported by the continued strong roll-out and uptake of the Covid-19 vaccination programme, which is one of the most advance in the world in terms of percentage of the population vaccinated. The currency was also supported by the low inflation rate in the UK, though there are fears that this will rise as the year progresses; Year-on-year comparison data will be distorted by the decline in economic activity seen in Spring 2020.

Emerging markets strong again

Emerging markets saw another strong performance in February, as investors continued to look to those emerging economies as most likely to be able to grow their way out of debt faster than the developed world. Whilst China saw a flat performance on the month, India was a highlight, with the Nifty 50 gaining more than 6.5%. The strength of the dollar is set to become more of a headwind for emerging markets, if it continues, though commentators do not generally expect this at present.

 

 

Equity markets across the globe saw a broadly positive month in February, supported by a pickup in the oil price, which reflected expectations of a gradual return to some form of economic normality this year. Technology and other growth stocks saw some profit taking, as investors rotated into value plays, and global financials, led by banks, saw many double-digit gains, as investors looked to rising US yields as an indication of further economic recovery and a steepening of the yield curve. Conversely, rising US yields also caused jitters across the equity markets, as investors feared rate rises to curb inflation.

 

February saw a widespread rally among European stocks. This was driven by a rotation away from technology, and into more value-led sectors. Financials, and particularly banks, performed well over the month. Good returns from major banks, and a sustained rally in the oil price, supporting Europe’s oil majors, led to buoyant markets, although concerns remained about the pace of the vaccine rollout, and take-up numbers. Lockdowns continued, but by the end of the month, there was some evidence to suggest that measures were working, particularly in the UK.

 

Sterling continued to gain ground against other major currencies in February. With one of the lowest inflation rates in the developed world, and with allocations to the UK increasing after the Brexit trade deal, the pound continued its ascent against the dollar, euro and yen. The dollar continued to confound expectations that it would weaken this year, rising some 2% against a basket of currencies from its early-January low. The strength of the dollar casts a cloud over forecasts for emerging markets this year, which are major beneficiaries of a weaker dollar.

 

Bond in all geographies and all parts of the fixed income universe saw a very poor month in February, as concerns about inflation led to a rise in yields, with bonds being sold off. Equities were spooked by the rise in yields, and an increase in volatility was seen towards the end of the month, as investors remembered the market correction in early 2018, which was triggered by the US 10y Treasury yield rising above 3%. The current rise only saw the 10y benchmark yielding 1.4%. Expectations of a steepening yield curve helped to boost bank shares, which performed especially strongly over the month.

*A Generic bond is a theoretical bond that always has the specified tenor, unlike a Benchmark bond, which is a physical bond, with a decreasing tenor.

Alternatives for Core portfolio construction

Received wisdom can be a hard thing to shake. For many years, investors were encouraged to adopt a 60/40 or 80/20 mix of equities and bonds in their portfolio, the idea being that the equities would provide growth, and the bonds would provide stability and downside protection. This was based on the long-run data that showed bonds to be far less volatile than equities. Indeed, for a long time, a portfolio like this would have served the investor quite well; taking the US market for example, where data is very readily available, a 60/40 mix of the S&P 500 Index and Barclays US Aggregate Index for bonds would have provided an average annual return of 10.7% between 1976 and 2019. Moreover, during this period, the portfolio would have lost more than 20% in only one year: 2008. Both equities and bonds provided positive returns during this period, with the yield on the 10-year Treasury bond averaging c.6%, and equities yielding c.5%.

How times have changed! Today, government bond yields are close to (or below) zero, equity yields on average are not much better, and volatility in the 7-15-year US Treasuries has hit 20% on more than one occasion since the global financial crisis of 2008. Moreover, when markets go bad, they have shown an increasing tendency to go bad in unison. In the pandemic panic of 2020, global bonds saw a drawdown of 14% – certainly better than the 35% fall in global equities, but hardly reassuring for an investor seeking stability.

The lower returns available from many assets have led investors to become more adventurous in their pursuit of gains. This means taking on more risk in order to achieve a similar return to what was available in the past. This risk can take many forms, such as:

• Illiquidity – such as presented by high yield bonds vs sovereigns
• Leverage – this can amplify losses as well as gains
• Concentration – more reliance on a smaller number of assets, thought to be ‘winners’
• Increasing allocation to riskier assets vs traditional defensives

So what can the investor do to help generate stability and protection in a multi-asset portfolio? One approach is to blend together a variety of strategies and asset types that draw upon diverse and – as far as possible – uncorrelated return streams, to provide a slow-but-steady return, that can help reduce directional exposure, cutting out a great deal of the drama. Strategies that we use at any given time may include:

• Short-dated (duration) bond funds
• Market neutral (long/short) equity and bond funds
• Short-biased (long/short) equity and bond strategies
• Derivatives-based trend-following strategies
• Macro and strategic funds
• Hedged share classes to eliminate currency volatility
• Absolute return equity and bond funds

Taking examples from these categories: funds that we have used across various mandates and times, and seeing how they performed over the first half of 2020, we get a much more comforting picture:

Hence, in today’s market environment, it is necessary to think carefully about portfolio construction before applying a simple bonds vs equities allocation. We believe strategy allocation and rotation over a cycle to help manage risk exposures is a powerful tool across actively managed mandates to help smooth out the journey and avoid unnecessary risks.

Portfolio construction at Collidr involves many layers that are all geared towards achieving the optimum balance of risk and return, smoothing out the portfolio journey, and protecting against market shocks. Strategy and fund selection are driven from our proprietary quantitative system, which indicates which are currently the most attractive asset classes, strategies and funds to be used in specific market environments (which are constantly evolving). But this is just the start of a rigorous process, which involves selecting the appropriate strategy approach to access the opportunity set, which leads us to the appropriate fund, then examining the correlation between the funds, to ensure sufficient diversification of returns, and finally blending the funds together in a portfolio, with weightings that ensure no one fund is contributing an excessive amount of risk to the overall portfolio.

 

Disclaimer: The information contained in this report is for illustrative purposes only and should not be construed as a solicitation nor offer, nor recommendation to acquire or dispose of any investment. Specifically, the share class used to create the illustrations may not be available on all platforms nor be suitable for individual investors. This report was produced by Collidr Research (“Collidr”) for Affinity Integrated Wealth Management (AIWM) and while AIWM and Collidr use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor Collidr make any representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are subject to change without notice. Model returns are calculated using the most appropriate share class of the underlying funds, having regard to the illustrative nature of the report, with all income being reinvested. As a result, real portfolio performance may vary from model performance. Where model portfolio histories are shorter than three years, historic model returns are substituted prior to inception date with returns from an Collidr performance benchmark. This benchmark is constructed from the average returns of all Collidr portfolios with similar risk profiles that existed during that time. The value of investments and the income from them can go down as well as up and past performance is not a guide to the future performance. Affinity Integrated Wealth Management is a trading style of Buryfield Grange Limited, Buryfield Grange Life Planning Limited and Affinity Integrated Wealth Management Ltd. ‘Buryfield Grange Limited’ is authorised and regulated by The Financial Conduct Authority. Not all services provided by Buryfield Grange are regulated by the Financial Conduct Authority. ‘Buryfield Grange Limited’ is registered in England and Wales at Inspire House, 20 Tonbridge Road, Maidstone, Kent, ME16 8RT. Company registration number 4568338. Collidr Research is a trading name of Collidr Technologies Limited, registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and Collidr.

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