Market Commentary – September 2019
Bond yields bounce on calmer outlook
After the rush to risk-off and the fall in bond yields seen in August, investors took comfort from US data, which appeared to show the economy still performing relatively well. Sovereign bond yields rose across most of the world as money flowed back into the equity markets, except for some weaker EU nations, where investors were still buying the relatively high yields available.
EU steady ahead of Brexit deadline
Equities across the continent held their nerve and managed to return a modest gain in most cases during September, despite no tangible progress in the Brexit talks. The Irish market bounced markedly from its sharp fall during August, gaining 6.2% during the month. The Supreme Court ruled that Boris Johnson’s proroguing of Parliament was unlawful, but opposition parties failed to press a vote of no-confidence, and so no general election is currently in prospect. Hopes remain that the Prime Minister will present a credible Brexit agreement to the EU.
US market soothed by lower oil and no escalation vs Iran
The general feeling that the US economy remains on track was boosted by a healthy retail sales figure for August. Sentiment among US investors was further boosted by a lower oil price and the absence of any escalation of the tensions between the US and Iran. Equities made modest gains over the month and are not currently focused on President Trump’s political difficulties.
Emerging markets stronger overall
Emerging markets recovered in September, rising 1.9% in USD terms, broadly in-line with developed markets. Returns were led by South Korean and Indian equity markets. South Korean stocks benefitted from an uptick in memory chip stocks such as Samsung and SK Hynix, which rose amid signs of a rebound in the memory chip market. Indian equities increased sharply following news from the Indian Government on 20 September that corporate taxes would be cut, with the base rate falling from 30% to 22%.
Global equity markets managed to stage a rally in September, after a miserable performance over the previous month. Although registering a modest gain overall, emerging markets occupied the extreme ends of the range, with Argentina gaining more than 18% and Venezuela losing more than 12%. Markets were underpinned by steady US data, showing a sharp rise in consumer spending and unemployment remaining steady at 3.7%. Europe and the UK were buoyed somewhat by the expectation that Prime Minister Boris Johnson was ready to present a workable Brexit deal to the EU.
European equities managed to rally during the month, with the major developed markets broadly returning between 2.8% and 4.1%. The Irish stock market bounced back strongly from its steep fall in August, gaining 6.2%, on renewed hopes of a compromise deal over the Irish border problem. Elsewhere on the continent, economic data continued to disappoint, with retail sales and inflation both falling.
Sterling continued to hold its own in the foreign exchange market for the second month in a row. After a fairly flat August, September saw the Pound making modest gains against most major currencies, most notably the Yen, which is often seen as a safe haven currency in times of geopolitical stress. The Yen weakened as news that the extradition bill behind the Hong Kong riots was to be withdrawn. The Dollar gained ground against several other currencies, but this owed little to USdriven news, and was more a function of activity elsewhere in the market. Positive sentiment surrounding a trade deal with Japan, and consequent hopes for a deal with China, were largely offset by concerns over the prospect of President Trump being impeached.
Global government bonds were weak in September, with the UK the only market to show a small gain overall. Investors around the world adopted a more relaxed stance after August’s bond rally, taking comfort from data that continued to show the US economy on track. Selling of government stock saw yields in most markets rise, with the ten year benchmark yields in Europe rising from their recent lows of -0.70%, although the ongoing search for yield led some of the weaker EU sovereigns to continue their yield contraction.
*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.
The importance of fund selection
Since the Brexit referendum in 2016, global investment markets have had to deal with a number of scenarios and events that have taxed even the most experienced investors. Aside from the referendum itself, we have seen the election of a US president with an idiosyncratic approach to foreign policy, collapses and rallies in various emerging markets, trade wars, currency gyrations and negative interest rates across much of the sovereign bond market. It is fair to say that nothing in any living fund manager’s experience will have prepared them adequately for this.
Perhaps surprisingly, markets have been largely benign during most of this period, although 2018 was challenging, particularly in the fourth quarter. It is easy therefore, to become complacent about fund selection. As President Kennedy often observed, when the tide comes in, all the boats rise. It is precisely in times such as these that investors should look to ensure that they are invested in the right funds, and will not only participate in the rise, but also enjoy some downside protection when markets eventually roll over. This requires an in-depth knowledge and a technical approach that are the hallmarks of Purple’s investment offering.
The first point where investors are apt to make mistakes is in trying to predict events or the future direction of markets. There is a natural human bias to assume that investments that have done well up until now, will continue to do well, despite short-term setbacks. The chart below shows a typical investment cycle:
This is one of the fundamental flaws in investor psychology, so much so that it has led Warren Buffet to adopt the mantra that you should “be fearful when others are greedy, and greedy when others are fearful”. This contrarian outlook has worked well for Buffet, but we prefer to disregard greed and fear, and look only at the current market conditions.
At Purple, we seek to remove this dangerous human bias by analysing the current set of market data objectively, using quantitative tools to determine whether at current valuations and momentum, markets offer sound investment opportunities, or should be avoided. Only once the markets that are attractive have been identified, do we decide what level of confidence we should employ in investing. If we are looking to take on a high level of risk, with commensurate opportunities for reward, or if we have a high level of confidence in a market, we may opt to use passive funds. These often offer a much cheaper way to invest in a market, as they merely replicate the performance of an index, and there is no judgement involved in stock selection. However, where the present data suggests that some degree of caution is required, we are more likely to use active funds, which may cost a little more, but benefit from the experience and judgement of a fund manager when selecting stocks.
Where investment is to be made through an actively managed fund, our next concern is to ensure that the best fund is chosen. The range of actively managed funds encompasses many different types of funds and approaches to investment. Some funds focus on buying shares that represent good value, others look for strong growth prospects, while some specialise in recovery situations. There are also thematic funds, which cover a certain sector of the market, such as energy, water or healthcare. Each of these types of funds has its own characteristics, and risks that we need to assess. We use our quantitative tools to rank, screen and measure managers by behaviour, i.e. how they are expected to behave in differing market conditions over a cycle. This is what sets us apart from many peers who tend to focus on short-term performance criteria. This then enables us to remove those human biases often inherent in managers and so allow us to construct a better diversified portfolio for clients for the long-term.
Our universe of approved funds has been researched and screened thoroughly, to ensure that all possible steps have been taken to minimise risks from factors such as liquidity, counterparty default, investment process and operational considerations. We examine not just the performance of the fund over certain periods, or against a benchmark or peer group, but how it has behaved during periods of market strength and periods of market weakness. Using this information, we can rank each fund within its peer group to see which funds are likely to perform best in the current market conditions.
Once we have arrived at a portfolio that represents the exposures that we consider appropriate and uses the funds that appear appropriate at present, we stress test the portfolio to ensure that returns from the selected funds show as little correlation as possible with each other in a sharp downturn scenario. Inevitably, returns from fixed income funds will all show some degree of correlation with each other, as will equity funds, but where we find the correlation to be too high, we often reject funds that we had selected in favour of less-correlated alternatives. This means that portfolio construction becomes an iterative process, adjusting and retesting the portfolio several times before we achieve the optimum balance between risks, correlations and diversification.
Even at this stage, the work of portfolio construction is not complete. The final step is to determine the weights for the different funds within the portfolio, and we do this using one of a number of optimisation techniques, based on minimising risk (wealth preservation) or maximising risk-adjusted returns (accumulation).
The portfolio that emerges at the end of the process is the result of hundreds of years of human investment experience and thousands of hours of systems development work, brought together to represent the purest expression of your investment objective.
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 Independent Strategic Research Limited (ISR) for Affinity Integrated Wealth Management (AIWM) and while AIWM and ISR use reasonable efforts to obtain information from sources which they believe to be reliable, neither AIWM nor ISR 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 ISR performance benchmark. This benchmark is constructed from the average returns of all ISR 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. ISR is registered in England and Wales at 34 Southwark Bridge Road, London, SE1 9EU. Company registration number 09061794. Data Providers: Bloomberg L.P. and ISR.
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