Overheating: a new source of concern

It has been a long time since investors have had to worry about overheating of the economic variety. In the decade that followed the financial crisis of 2008/9, economic growth was persistently sluggish and “animal spirits” generally subdued. We are in a very different place today, with governments, companies and consumers all looking to invest or spend. Investors are starting to worry that central banks may soon have to cool things down.

Recent portfolio changes have helped us in this new environment. In the fourth quarter of last year, we increased our exposure to more economically-sensitive areas of the market. This has worked well as these sectors continue to play catch-up. We increased this exposure more recently with the addition of a “deep value” fund with overweight positions in financials and energy – sectors which are finally enjoying a period of stronger performance after being out of favour for many years. Historical data suggests these sectors should continue to perform relatively well in a period of slightly higher inflation.

Sector performance can vary materially

MSCI World Index vs. selected global industry sectors, last five years

^{Source: Cazenove Capital, Refinitiv Eikon}

While these purchases have changed the overall composition of our portfolios, we still have a slight bias towards “growth” sectors. This reflects our commitment to longer-term themes such as technology and healthcare, which we think will offer opportunities for years to come. Other themes that we continue to hold as core positions include infrastructure and energy transition, both of which should benefit from governments’ focus on “building back better” after the pandemic.

In multi-asset portfolios, we recently increased our weighting towards absolute return funds. These vehicles are designed to deliver less correlated returns with lower volatility. We think they have a particularly attractive opportunity set at the moment given the continued dispersion in valuations across sectors and markets.

We also maintain the “defensive ballast” in multi-asset portfolios. The threat from the pandemic has not gone – and could become more severe over the autumn and winter. Inflation, and the potential central bank response, could also be a trigger for renewed volatility. 

Based on our inflation view, we have been reducing our exposure to conventional US treasuries in favour of inflation-linked treasuries ("TIPS"). This should allow us to benefit from the safe haven characteristics of US government debt while offering inflation protection. We also continue to hold gold. Its traditional role as a hedge against inflation could mean it is in high demand in a period of sustained price rises.