Preparing for a stormy autumn

Equities will always play an important role in our multi-asset portfolios. They have a strong track record at generating returns ahead of inflation and, with inflation set to remain above long-term average levels for some time, this is something we are very mindful of. However, given the challenging outlook for the global economy, we have chosen to tactically reduce our exposure to equities this year.

Cutting equity exposure

This has happened in several stages. The first move came at the end of the first quarter with a broad reduction of global equity exposure and a large cut to our European exposure, given concerns over the longer-term economic impacts of Russia’s invasion of Ukraine. We also shifted exposure towards larger, higher-quality companies that we felt could better navigate an increasingly  challenging economic backdrop. 

Between mid-June and early August global equity markets rallied by over 16% as investors began to speculate that central banks may “pivot”  from combating inflation to supporting growth. We felt that this stronger performance did not represent the start of a more prolonged recovery and it was premature to assume that equity markets were out of the woods. This proved to be correct. 

We took advantage of the rally to further reduce our equity allocation. For UK clients, this was achieved by reducing exposure to UK mid-cap companies with greater sensitivity to the fortunes of the UK economy. While the introduction of the energy price cap will go some way to supporting the consumer through the cost-of-living crisis and offer near-term relief to domestic businesses, the outlook for the UK economy remains uncertain.

A difficult year for bond markets

Government bond yields have moved higher - and prices lower - as central banks raise interest rates in response to elevated inflation. So far this year, UK government bonds have fallen over 20%, whilst US treasuries are also down close to 12% (in USD terms). We have had limited exposure to government bonds this year, preferring to allocate to short dated, high-quality corporate bonds as well as floating-rate securities which have fared relatively better. 

With yields on UK and US government bonds at the highest level in over a decade, and Western economies moving closer to recession, government bonds are starting to look relatively more attractive as a defensive asset. We are looking to gradually increase exposure. 

The closer correlation of returns between equities and bonds this year has posed a challenge to multi-asset investors, as the diversifying benefits of government bonds have been greatly reduced. In this environment, owning a broader range of alternative assets, including absolute return funds, real assets and  commodities, has proven to be a better source of diversification.

Why we still like commodities

Commodities have performed particularly well well this year. They have been a good hedge against the disruption to energy markets and inflationary implications of the Russian invasion of Ukraine. We are however conscious that historically, commodity markets have been sensitive to the economic growth backdrop. With slowing global growth, the question is whether to maintain our exposure to the asset class. 

The Russia-Ukraine conflict shows little sign of de-escalation. The disruption of European gas supplies could continue with broader implications for global energy markets, particularly as we start to see higher demand in the winter months. While weaker global growth may see falling demand for certain industrial metals, we continue to see value in maintaining some exposure to commodities as a hedge against rising energy prices.