Market Commentary – January 2019

Global equities bounce back

Major equity markets around the world bounced back from the falls seen at the end of 2018, in January, led by the US, where the S&P 500 Index recovered nearly 8%. All the major markets saw gains, with the larger emerging markets following suit. Falls were seen in frontier markets and some smaller emerging markets.

Sterling rallies as Brexit deadline approaches

Despite no tangible progress towards a Brexit deal, overseas investors began to move back into Sterling. The UK equity market had been under-owned by international managers, and recent events in Parliament seemed to focus attention on an extension to Article 50, a second referendum, or another agreement that would keep the UK in the EU customs union.

Bonds back in favour, as economic data weakens

Dramatically weaker economic data coming from Europe, and lower inflation numbers in many markets led to a rally in bonds, as investors took the view that central banks, particularly the Federal Reserve, might take a more dovish monetary stance in 2019. The 10-year Treasury yield fell to just 2.63%, from its high of almost 3.3% last year.

Weaker Dollar and trade talks boost emerging markets

Many of the larger emerging markets, such as China, South Korea and Brazil, saw strong rises in January, buoyed by a weakening in the US Dollar, and hopes that the current truce between the US and China in their trade dispute will lead to a permanent settlement. The truce will last until the end of March, and talks between the US and China are ongoing.

China sees slowest growth in 28 years

The slowing in Chinese economic growth weighed heavily on Asian markets at the start of 2019, with Japn’s Nikkei 225 Index trading as much as 3% lower on the first day of the new year. However, optimism about a possible settlement of the trade dispute with the US, and the return of investors after a substantial re-rating of Chinese shares in 2018 saw the Chinese equity market rise by more than 8% in Sterling terms over the month.

January saw global equity markets start the year in a more positive mood. Each of the major markets showed a significant bounce from the falls seen at the end of last year, and falls were limited to frontier markets, and some emerging markets. The USA was the best performing of the major markets, rising by 5.3% in Sterling terms, despite a rally in the Pound. The UK followed, returning +4.5% (+3.6% for the FTSE 100 Index), with a similar result coming from the EU nations overall. Among the emerging markets there was a range of returns, from +18% (Pakistan) to -18% (Romania), with the larger markets, China, Russia and South Korea all recording strong gains during the month. Renewed hope for a settlement of the Sino-US trade dispute and widening expectations of fewer rate rises from the Fed in 2019 helped to buoy sentiment.

Equities across the the continent gave a very mixed return, but the major markets all showed a rebound from their December weakness. France, Germany and Italy returned +2.9%, +4.1% and +5.5% respectively, whilst the UK rose by 4.5% and Sterling rallied as the rejection of the Prime Minister’s Brexit proposition led to optimism about a postponement of Britain leaving the EU. Bonds across the UK and Eurozone also rallied as economic data from Europe continued to weaken, which, together with the end of QE, led to the expectation that rate rises from the ECB would not come through in the near future.

Sterling appreciated in value against the Dollar, Yen and Euro during January. Whilst the changing expectations for Brexit undoubtedly played a part in this, it is also likely that Q1 allocations to the UK from global fund managers were higher than at the end of last year. A similar situation obtained in the Chinese market, where some investors have begun gingerly increasing their weightings after a year that saw a 30% drawdown in Chinese equities. The Euro was weakened by the continued softening of economic data coming out of the Eurozone.

Bonds around the world were generally strong in January. The exception to this was UK Index-Linked Gilts, which ended the month slightly lower, as inflation expectations began to waver. Poor economic data coming from Europe led to buying of EU bonds as expectations for a rate rise from the ECB receded. Similarly, US Treasuries rallied as a slight flattening of the yield curve led many commentators to speculate that there would be no more than two rate rises from the Fed this year, rather than the four increases that had been predicted a few months ago. 10-year yields around the globe contracted during the month, with the most noticeable falls coming from the weaker EU nations. *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.

Liquid Alternatives December Performance

In December, when global markets continued to tumble (FTSE World Index Total Return GBP was down 7%), it was comforting to see some of our best alternative ideas stand out for their resilience ahead of other peers. These represent absolute return strategies that aim to behave in an uncorrelated manner to traditional ‘long-only’ managers, while withstanding market volatility of the type witnessed in December.

Our preferred funds in the alternatives category generated the following returns last month:

• Artemis US Absolute Return: +0.2%
A US focused long-short equity strategy where the manager maintains a low net exposure and has a cautious outlook.

• Blackrock Absolute Return Bond: -0.27%
A diversified bond strategy led by an experienced manager and fixed-income research team. Focused on managing draw-down risk.

• Hermes Absolute Return Credit: -0.36%
A long/short credit strategy that extracts value across security selection rather than just issuer. Adopts strong relative value approach to sourcing returns.

• Montlake Dunn WMA: +2.1%
A Medium to long-term trend follower with a strategy in existence since 1974. Offers diversification and lower correlation to markets.

• DB Platinum Selwood Market Neutral Credit: +0.7%
A market neutral credit focus, exploiting arbitrage opportunities between implied and actual credit default rates.

• Invesco Perpetual Global Targeted Returns: +0.57%
A multi-strategy fund which seeks returns across all major asset classes via a conviction-led approach to idea generation.

• JPM Global Macro Opportunities: -0.34%
A discretionary macro strategy combining thematic, risk-adjusted idea generation with bottom-up strategy selection across all major asset classes.

The list of names above tend to have some key factors in common when we carry out our due diligence on them – namely, that the managers have strong pedigree running a particular strategy, typically managing their strategy for five years and more; additionally, we look for consistency in manager behaviour, assessing how these strategies stand out in ‘stress’ events, while also ensuring that they are lowly correlated to markets and other managers held in client portfolios.

These alternative fund ideas are blended with other similar strategies in client portfolios with the intention of creating a consistent return stream over the long-term. These core fund ideas ultimately act as a ‘stabiliser’ mechanism for client portfolios, driven by our behavioural analysis of managers to understand how they perform in ‘up’ or ‘down’ market scenarios.

The charts below highlight some of the above funds as examples of how they tend to exhibit superior performance and lower volatility relative to a suitable comparator over the whole of 2018. In each case, you can see how the fund typically shows a better return than its comparator over 2018, along with much lower volatility (as measured by the standard deviation) and lower correlation too. What is clear is how these strategies deliver a steady level of return throughout this period compared to much more volatile markets over the same period. This illustrates the above factors we look for in managers that are typically in our portfolios, particularly with reference to repeatable and consistent strategies, that we use to help stabilise the return and provide a smoother journey.

The final chart below compares the above funds against a generic absolute return index for last year. You can see how they are all in a relatively tight band between -2% to +3%, considerably better than global equity markets. They compare well against multi-strategy, absolute return funds such as Standard Life GARS (‘SLI GARS’) and Aviva AIMS Target Return (‘TR’) which are plotted on the same chart. You can see how our Absolute Return holdings fare much better when compared to SLI GARS or AIMS TR over last year, both in terms of return and volatility (bar JPM Global Macro Opps by a small margin).

Disclaimer: FOR PROFESSIONAL USE ONLY.

This report was produced by Independent Strategic Research Ltd (“ISR”). The information contained in this report is for informational purposes only and should not be construed as a solicitation or offer, or recommendation to acquire or dispose of any investment. While ISR uses reasonable efforts to obtain information from sources which it believes to be reliable, ISR makes no representation that the information or opinions contained in this report are accurate, reliable or complete. The information and opinions contained in this report are provided by ISR for professional clients only and are subject to change without notice. You must in any event conduct your own due diligence and investigations rather than relying on any of the information in the report. All figures shown are bid to bid, with income reinvested. As model returns are calculated using the oldest possible share class, based on a monthly rebalancing frequency and all income being reinvested, real portfolio performance may vary from model performance. Portfolio performance histories incorporate longest share class histories but are either removed or substituted to ensure the integrity of the performance profile is met. 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. ISR and Independent Strategic Research are trading names of Independent Strategic Research Ltd, registered in England and Wales No. 09061794. Registered office: 34 Southwark Bridge Road, London, SE1 9EU, UK.

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