Recovery brings new risks

Over the past year, investors have learnt to live with the pandemic. After an initial panic, stock market performance clearly split between Covid “winners” (such as technology) and “losers” (leisure). The approval of a vaccine – months sooner than most anticipated – has more recently upset this re-classification of the investment world. Investors have now started to re-engage with those sectors that were hardest hit by the pandemic and ensuing economic contraction.

Cyclical recovery

We came into the year with an overweight allocation to “growth” sectors. These have generally emerged as Covid winners, helping us navigate the year successfully. We have now moderated this exposure through an allocation to funds with more of a “value” focus, while maintaining an emphasis on quality.

Performance of S&P 500 Growth vs S&P 500 Value, last five years, rebased to 100

^{Source: Refinitiv Datastream, Cazenove Capital}

These more cyclical sectors recovered substantially in the last two months of 2020 – but we think the rebound could have further to run. In the near-term, this would favour markets with more of a “value” bias, such as the UK. This would in turn lead to a broadening of global equity market performance, which in 2020 was very dominated by the US and in particular its large technology companies.

Over the longer-term, we maintain our conviction in the key themes that I have discussed throughout the past year. These include technology and healthcare, where we have exposure to specialist funds. We also expect to see continued pressure on governments to provide fiscal support, which should help infrastructure. The sector offers a compelling combination of stable, inflation-linked returns and the opportunity to benefit from the energy transition.

Maintaining our diversified exposure

In multi-asset portfolios, we maintain our allocation to government bonds and gold, both of which offer valuable diversification benefits. Today’s very low interest rates are supportive of these asset classes. With unemployment still at elevated levels in major economies, this is unlikely to change soon. However, we recognise that greater economic optimism could see defensive assets experience more volatility over the coming months.

The strong performance of gold, and US equities, has in some cases left with us with a slightly larger exposure to US dollars than we might like. To reduce this, we switched some of our gold exposure into a GBP-hedged vehicle, to limit the impact of currency swings for GBP-based investors.

More generally, we continue to see interesting opportunities within alternatives. Market neutral hedge funds are one example of this. Our research shows that they can provide attractive returns with relatively low volatility and low correlation to equity markets. Such strategies should be able to capitalise on a particularly attractive opportunity set at the moment, given the high degree of performance and valuation dispersion we see in equity markets.