Reimagining multi-asset
How can investors remain at the forefront of innovation and ensure true diversfication in 2025?
present
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Against a backdrop of elevated volatility, Newton head of mixed assets investment Paul Flood outlines the multi-asset team’s latest thoughts on bonds, equities and alternatives.
Current multi-asset positioning
Throughout 2024, a rapid and welcome fall in inflation inspired hope that the pricy post-pandemic days were behind us. However with several inflationary factors converging, investors risk underestimating long-term inflation risks, leaving their portfolios vulnerable.
Inflation: on track or off course?
In what ways has the world changed since the end of the pandemic? Will those changes continue? And what implications does regime change have for multi-asset investors?
What investors need to know about the 'new regime' for multi-asset investing
Interest rates are likely to continue into this year. So, when staying in cash is an attractive option, why should clients consider taking on investment risk? Quilter Investors answer this question and explore the impact of the US election and the Labour Budget on investors.
Do higher-for-longer interest rates weaken the case for investing?
Latest insights
How can investors remain at the forefront of innovation and ensure true diversification in 2025?
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Previous insights
What’s the difference between a fund of funds (FoF) and a managed portfolio service (MPS) – and which is right for your client? Quilter Investors explore each investment solution’s unique characteristics and their different uses in financial planning.
Navigating multi-asset investing: Fund of funds vs managed portfolio services
Multi-asset investors can enjoy attractive returns without placing a concentrated bet on mega-cap growth stocks in the US.
Looking for diversity? Look beyond the US and tech stocks
Newton portfolio manager Janice Kim assesses some of the key macroeconomic themes she thinks could influence multi-asset investors’ decision making in the year ahead.
Four macro themes for multi-asset investors
Although the classic portfolio of 60% equities and 40% bonds has delivered a terrific balance of risk and return for investors in recent decades, Orbis Investments believe its future prospects appear far less promising. In the face of shifting market dynamics investors need to adjust their expectations or their portfolios.
Why 60/40 no longer fits the bill
In the post-Consumer Duty world, blended portfolios have surged in popularity. But why, exactly? Hear from Ryan Medlock, Investment Director, who explains why blending passive strategies with flexible active management can manage risks and maximise opportunities.
Creating a special blend
With the US tipped to win the stock market race this year, why diversify? Andrew Miller, Lead Investment Director, gives solid evidence of why the only surefire bet in 2025 is to predict the unpredictable, and how a multi-asset approach can help.
Predicting the unpredictable
A simple multi-asset portfolio focused on dividend-paying equities and high-yield bonds can offer downside protection and help investors to meet their long-term goals
How a focus on income can deliver long-term growth
Jack Holmes says that the risk/reward trade-off in shorter-dated high-yield bonds is more compelling than in government debt.
Why high yield doesn’t mean high risk for multi-asset portfolios
Newton mixed assets portfolio manager Simon Nichols outlines four shifts underway in the global investment landscape and how they could influence markets and multi-asset investing.
Multi-asset: macro themes that matter
A new approach to multi-asset is required, says Newton multi-asset chief investment officer Mitesh Sheth – one, he argues, that could see liquid alternatives play a bigger role in portfolios.
A new dawn for multi-asset?
In today’s environment of concentrated markets, persistent inflation, and heightened correlations, achieving genuine diversification is more challenging than ever. However, it’s far from impossible.
Redefining diversification in a concentrated market
Global markets remain divided, with US mega-cap stocks dominating valuations while many high-quality businesses elsewhere are overlooked. Orbis Investments explores where value can still be found – for those willing to look beyond the obvious.
Markets are still cheap – if you know where to look
A simple multi-asset portfolio focused on dividend-paying equities and high-yield bonds can offer downside protection and help investors to meet their long-term goals.
The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed. Important information For Professional Clients only. This is a financial promotion.
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes.
Sources 1. FCA.org.uk. Reforms to financial services retail-disclosure requirements. 19 September 2024.
For further information visit bnymellonim.com
“Equity valuations remain elevated, but we are seeing earnings growth broaden out across the market”
10-year government yields – US, UK
Source: Bloomberg, 8 November 2024.
US 10-year treasury yield
UK 10-year gilt yield
MSCI World earnings per share expectations (US$)
Source: FactSet, IBES consensus, 30 September 2024. P/E – Price to Earnings.
2022
2023
2024
9%
Paul Flood, Head of Mixed Assets Investment
CONTRIBUTOR
At the beginning of 2024 we felt a lot of rate cuts were being priced into the market, so we reduced the allocation to bonds. During the growth scare we saw in August 2024, when equity markets sold off, we saw good returns from the bond market. In terms of current market observations, since the US presidential election, yields on the 10-year US Treasury and 10-year gilt have been moving towards 5%. This is likely because the market has priced in inflationary concerns arising from both government fiscal spending and some of the Trump policies. Since the end of Q3 2024, we have been adding back into the bond market at the longer end where we're getting up to 5% particularly in the UK gilt market. We think 5% sounds reasonable, given where inflation is. If the central banks are successful at keeping inflation at target, that could lead to a 3% real return which we believe is attractive.
Bonds
Equity market valuations are elevated. In fact, valuations are in similar territory to early 2022, driven by growth stocks, particularly the ‘magnificent seven’ group of technology companies. Looking back, we reduced equities going into 2022 and increased that going into 2023. More recently, however, we've been conscious of valuations. So, while equity weightings haven't changed dramatically, we have made reductions to our technology exposure, given how strong this sector has been.
Increased concentration within indices and equity portfolios is something the team is concerned about, but we have been observing earnings numbers starting to grow across the broader market. One area of opportunity we see in equities is stemming from the manufacturing renaissance, particularly in the US. The boom in artificial intelligence and the related increase in data centres and areas like cloud computing are likely to create significant demand for electricity.
Equities
The alternatives space has seen weakness of late. This can be explained, in part, because higher interest rates have resulted in greater demand for bonds, so competition for investors’ capital has been fierce. Other contributors to weakness have included the debate around cost disclosure for investment trusts, as well as pension funds selling risk assets as they offload balance sheet risk to match liabilities. We reallocated some of the alternatives’ exposure through 2022 and 2023 into the bond allocations within portfolios. But we are now more optimistic on alternatives. One reason for this is financial services retail disclosure requirements are being reformed . We think this could entice multi-asset investors back into the investment trust space. Another reason for optimism is the inflation-linked nature of some renewables. With concern around inflation remaining higher, the inflation-linked cash flows characteristic of the renewables space could be positive for investors, providing portfolio diversification against bonds and equities.
Alternatives
The Newton multi-asset team has been adding to bonds across portfolios on the belief they provide diversification. Meanwhile, equity valuations remain elevated, but we are seeing earnings growth broaden out across the market. Elsewhere, we are optimistic on certain alternatives.
1
RETURN TO HOMEPAGE
The value of investments can fall. Investors may not get back the amount invested. Important information For Professional Clients only. This is a financial promotion.
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For further information visit http://www.bnymellonim.com.
US fiscal deficit (% of GDP)
Source: CBO ‘The Budget and Economic Outlook: 2024 to 2034’, June 2024 (CBO projection from 2024).
US implied overnight rate & number of hikes/cuts
Source: Bloomberg (WIRP - World Interest Rate Probabilities), 6 November 2024.
Number of hikes/cuts priced in
Implied policy rate (%)
“Combined with other dynamics like ageing demographics and the rising costs of healthcare, and higher debt, investors have called into question whether government spending is sustainable”
One theme emerging in this new regime is increasing state involvement in economies. This is evident in the US and other nations through larger fiscal deficits (see chart below) and rising government debt to GDP levels. This is likely to continue given some of the structural shifts underway like deglobalisation and reshoring. Combined with other dynamics like ageing demographics and the rising costs of healthcare, and higher debt, investors have called into question whether government spending is sustainable.
But can economies grow their way out of their debt situations without inflation spiralling? In the US, prices have cooled and despite higher interest rates the economy and labour market have been reasonably resilient. That said, new US job additions have been declining, leading to a debate around growth versus inflation and where interest rates are likely to go from here.
Big government
The market’s expectation on interest rate cuts has lowered. In summer 2024 nearly seven cuts were being priced in. Today, the market is pricing in four cuts over the next five quarters, which would leave the policy rate at about 3.8% by the end of 2025 (see chart below).
But investors are divided on the path for interest rates. One side argues growth has been resilient in a higher rate environment. Therefore, slow moderate cuts would ensure the inflation genie is put back in its bottle. On the other side, however, people expect more aggressive rate cuts to pre-empt any sort of severe recession now that we've seen evidence of a slowing labour market in the US. We expect this tug of war to continue with the markets remaining focused on employment data.
Interest rate ‘tug of war’
Following Donald Trump’s election victory, the market's focus has shifted from political uncertainty to policy uncertainty. Key themes for Trump's second term appear to be tariffs, immigration, deregulation, and lower taxes and fiscal spending. The Republicans may be able to advance Trump's agenda more easily with the House and the Senate both under Republican control. In the UK, the Labour Party’s budget in October 2024 delivered an increase of around £40bn in taxes . Businesses are set to do the heavy lifting on this, with higher National Insurance (NI) contributions expected to bring in the bulk of that total . This additional NI burden may end up being a drag on economic growth if businesses look to cap wage growth and limit hiring and investment, especially employers of lower paid workers. The UK government also announced current (day-to-day) spending is projected to rise by £47bn (1.4% of GDP) by 2029/30 . The discrepancy between expected tax revenues and spending has meant higher borrowing, all at a point when borrowing costs are high. The UK faces similar issues around fiscal deficits and government debt levels as the US. But we are seeing divergent policies between the UK and US economies. The Trump administration appears to be laying plans to reduce public spending and maintain lower taxes, while the UK is effectively doing the opposite. These divergent policies could potentially lead to very different longer-term outcomes in growth and inflation for the UK and the US.
Political moves
Growth has also been a challenge for China, the world’s second-largest economy. While the Chinese government’s economic stimulus measures have revived hopes of a consumption recovery, the question remains as to whether the government can, in fact, jumpstart the economy back into growth mode. The China market trades at around 10 times earnings . This makes valuations for certain quality Chinese companies looking compelling, even in the absence of any government stimulus.
China
For a long time, investors were used to an environment led by monetary policy, globalisation and free trade, low to zero interest rates and disinflation. But the world is now dominated by fiscal measures, increased protectionism, deglobalisation and reshoring, higher debt costs, and potentially higher inflation. We ask ourselves whether this paradigm shift will drive a return to cyclicality and increased volatility. As multi-asset investors, we view volatility as our friend. It allows us to take advantage of market dislocations across asset classes and find attractive entry points for areas of long-term opportunity.
Sources 1. Guardian. Budget 2024: Reeves reveals £40bn in tax rises as she promises to rebuild public services. 30 October 2024. 2. Financial Times. Businesses and wealthy bear brunt of £40bn tax increases in UK Budget. 30 October 2024. 3. Capital Economics. Despite large rise in taxes, Budget still boosts economy. 30 October 2024 4. Bloomberg data, as at 29 November 2024. On a forward-looking price-to-earnings (P/E) basis, based on the MSCI China Index.
2
3
4
Janice Kim, Portfolio Manager
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any statements are based on Artemis' current opinions and are subject to change without notice. They are not intended to provide investment advice and should not be construed as a recommendation Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.
Find out more about the Artemis Monthly Distribution Fund
“In bond markets, the explosion in debt-to-GDP ratios across much of the world may suggest that it would be imprudent to take a 'buy-and-hold' approach to government bonds, particularly at the long end of the curve”
Quantitative easing (QE) Worries about deflation Austerity Long-duration government bonds Globalisation Peace Capital-light platforms Profitless growth Just-in-time supply chains
Then...
Now...
Quantitative tightening (QT) Uncertainty about inflation Debt-to-GDP >1OOo/o Short-dated corporate bonds Nearshoring / autarky War Capital-intensive industries Dividend yields Just-in-case inventory
Jacob de Tusch-Lec, Co-Fund Manager, Artemis Monthly Distribution Fund
Our expectation is that the world described in the left-hand column of our table will continue to give way to the one on the right. That process won't, however, always be smooth; it will come in fits and starts. There will be reversals. In contrast to the decade in which QE artificially suppressed volatility and pushed the valuation of long-duration assets steadily higher, its withdrawal seems likely to provoke it. In bond markets, the explosion in debt-to-GDP ratios across much of the world may suggest that it would be imprudent to take a 'buy-and-hold' approach to government bonds, particularly at the long end of the curve. In equity markets, investors will need to be nimble and be prepared to take short-term tactical positions that may be at odds with the long-term direction of travel. The new regime may not necessarily be an environment in which it pays for multi-asset investors to run their winners - but instead to be active and agile. That suits us.
In the new regime, we are not expecting to 'buy and hold'
If you've attended one of our presentations or webinars over the past few years, you'll have heard us explaining why we believe the world is in the middle of a process of 'regime change' of the type only seen once every few decades. You'll probably also have seen a version of the table below. It contrasts the winners of the decade that followed the global financial crisis with the beneficiaries of the new political, economic and financial regime. We initially drew it up to help clarify our thinking about the big picture for equity markets but it also carries important implications for multi-asset investors.
When we first drew up this table, quantitative easing (QE) was still holding down long-dated bond yields, Russia had yet to begin dropping missiles on Kiev and interest rates across the West were close to zero. At that time, our preference for owning the shares of defence contractors, banks and companies controlling tangible assets in the 'real world' looked out of step with a broader market fixated on long-duration growth stocks with intangible assets. The dramatic sell-off in bond markets in 2022, however, marked a watershed: the end of the pre-pandemic monetary regime. Russia's wholesale invasion of Ukraine, meanwhile, gave vivid expression to the world's ongoing descent into a less stable geopolitical era. And now?
As the world has become less peaceful, defence stocks have performed incredibly well. The rise of political populism (itself a reaction to the rising inequality that a decade of QE fuelled) has seen decades of globalisation being replaced by nationalism and the onshoring of strategically important industries. Building and powering Al data centres - and incorporating renewables - has propelled demand for semiconductors, smart power grids and nuclear reactors. With interest rates and bond yields having moved meaningfully higher relative to their pre-pandemic levels, the profitability of banks and insurers has been transformed.
• • • •
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Reference to specific shares or companies should not be taken as advice or a recommendation to invest in them. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Any statements are based on Artemis' current opinions and are subject to change without notice. They are not intended to provide investment advice and should not be construed as a recommendation. Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.
“The depth and diversity of the world's equity markets should make them a core hunting ground for multi-asset investors”
Apple Nvidia Microsoft Amazon Meta Tesla Alphabet (A) Alphabet (C) TSMC Broadcom Total
4.54 4.27 3.76 2.47 1.58 1.25 1.25 1.08 0.95 0.91 22.05
32x 33x 30x 36x 23x 126x 21x 21x 18x 36x
Top 10 constituents MSCI AC World Index
Proportion of index (%)
12-month forward p/e
Source: MSCI, LSEG Datastream as at 31 December 2024
One result is that US stocks now account for almost 70% of the global equity market by value (up from around 40% in 2008) . You might reasonably argue that doesn't matter: America's technology giants are, in reality, global - rather than local - businesses. Of potentially greater concern, however, is that the 10 largest stocks by weight in global index today appear to be thematically linked.
A narrow group of companies and investment themes have progressively come to dominate global indices
To varying degrees, the lofty valuation multiples of all of these businesses are being supported by the assumption that generative Al has permanently transformed their earnings potential. The problem, however, is that if you allocate your capital to these businesses in anything approaching their index weightings (together, these 10 stocks account for around a quarter of the MSCI AC World Index) you will have assembled a lopsided portfolio whose returns are skewed towards one type of business. If your equity portfolio resembles the index, you're taking a significant bet on technology, on US growth stocks and on Al. That bet might pay off- but it should not be mistaken for genuine diversification. Given the narrowness of markets, investors may be at risk of over-allocating to a small group of stocks while simultaneously under-allocating to other potential sources of return.
The good news is that exposing your equity portfolio to a variety of future cashflows has not necessarily meant sacrificing returns in the near term; it is possible to harvest attractive returns from global equities without placing an outsized wager on US mega-cap growth stocks. In 2024, for example, investors could have enjoyed market-beating returns by investing in dividend-paying (and reasonably valued) stocks in such diverse areas as:
The depth and diversity of the world's equity markets should make them a core hunting ground for multi-asset investors. But before you commit too much of your financial future to a narrow group of the most widely held (and often expensive) stocks, consider taking a wider view - and looking beyond the usual suspects.
There are other (profitable) themes and sectors to follow
Investors in multi-asset funds will be familiar with the power of diversification, 'the only free lunch in investing'. Spreading your risk across a variety of assets with different characteristics in a range of political and economic regimes - giving your portfolio exposure to a spread of future cashflows - provides valuable insurance against the unexpected. Yet while most multi-asset funds deliver instant diversification on an asset-class level, the increasingly concentrated nature of capitalisation-weighted stockmarket indices suggests that investors may need to look beyond 'the usual suspects' if they are to reap the benefits of diversification on a company level.
Sources 1. American stocks are consuming global markets 2. All returns: LSEG Datastream as at 31 December 2024
Over the past decade, a handful of interrelated themes have characterised global markets:
The outperformance of US equities. Hopes that generative Al will permanently transform the earnings potential of a group large, technology companies. The outperformance of 'growth' stocks relative to their 'value' counterparts.
• • •
Gold miners (In sterling terms, Canada's Kinross Gold returned 59% in 2024). Enablers of the energy transition (Germany's Siemens Energy returned 299%). Banks and insurers (South Korea's KB Financial returned 43%). Engineers (Japan's Mitsubishi Heavy Industries returned 149%). Defence contractors (Germany's Rheinmetall returned 106%) .
• • • • •
James Davidson, Co-Fund Manager, Artemis Monthly Distribution Fund
Important information For Professional Clients only and not to be distributed to or relied upon by retail clients. Past performance is not a guide to future performance. Opinions and examples represent our understanding of markets: they are not investment recommendations advice. All data is sourced to Aegon Asset Management UK plc unless otherwise stated. The document is accurate at the time of writing but is subject to change without notice. Data attributed to a third party is proprietary to that third party and is used by Aegon Asset Management under licence. Aegon Asset Management UK plc is authorised and regulated by the Financial Conduct Authority. Adtrax 6105984.1; Expiry 30 April 2025
Sources 1. www.statista.com 2. What worked (and didn’t work) during 1970s stagflation 3. Investing during Stagflation: What happened in the 1970s 4. www.bankofengland.co.uk 5. www.sipri.org
Learn more about Orbis Investments
“We may be unlikely to return to the exceptional inflation rates of the recent past; however given the damage that persistent inflation has wreaked upon bond and equity markets in the past, investors would be wise to keep their guards up”
XXXXXX
Source: 31 Dec 2023. Indicative estimates only. Forecasts are inherently limited and cannot be relied upon. Source: International Monetary Fund, World Bank, International Energy Agency, Lazard, US Bureau of Labor Statistics, Eurostat, UK Office for National Statistics, Japan Ministry of Internal Affairs and Communications, Japan Ministry of Health, Labour, and Welfare, LSEG Datastream, Orbis. GFC is the 2008-2009 global financial crisis. Inflation for advanced economies, proxied by the US, European Union, UK, and Japan, weighted by GDP at current USD levels.
Structural forces could drive higher long-term inflation
Potential contribution to consumer price inflation, advanced economies
Our electric grids are aging and need replacing
Average age of global electricity cable and other grid infrastructure
Inflation (CPI)
Cash ISA rate
40
35
30
25
20
15
10
5
0
Europe
North America
Latin America
South East Asia
Rest of Asia
Middle East
Africa
Design life of grid infrastructure:
30 years
Source: 31 Jul 2024, Nexans.
After the Covid lockdowns at the start of the decade, the global economy recovered at a startling pace. In the UK, social-distancing mandates were lifted in mid-July 2021, and by March 2022 unemployment rates had fallen to pre-pandemic levels. Stimulus measures enacted to keep economies afloat – like furlough schemes in the UK and government-issued cheques in the US – meant many businesses had money for hiring once the services and hospitality industries reopened. The rise of hybrid working also gave skilled workers the ability to look further afield for well-paid jobs, pushing wages higher as companies competed for the best employees. Ageing demographics have been upping labour costs too; the retirement of the outsized Baby Boomer generation means more jobs for fewer workers, which increases wage competition.
Increased labour power is influencing wage growth
...from a globalisation perspective, at least. If trade in the 20th century was defined by nations coming together, the 21st century has to be defined by much more protectionist policies. This trend came to prominence in 2016 with the UK’s Brexit vote and Trump’s first presidential victory. But it has since become resurgent, with geopolitical tensions leading to higher shipping costs and greater ‘onshoring’ of supply chains; renewed protectionism in India; populist gains in the European Parliament and EU tariffs on Chinese vehicles; and now Trump’s re-election. While the aim of less dependence on outside nations is to keep financial successes close to home, protectionist policies can lead to inflation. Supply chains get jammed up or entail high taxes on materials imported from abroad. Businesses then pass these expenses on to consumers in the form of higher prices. And with less international competition, domestic producers can raise their prices.
The world is getting smaller...
Even worthy causes come with costs. In the coming years, countries and companies around the world will be looking to update their energy infrastructure, either out of necessity or from a desire to go greener as global temperatures rise. The chart below shows that almost all regions of the world are fast approaching the 30-year mark that indicates the need for upgrades. Europe and North America, two regions whose monetary policies tend to have knock-on effects for the rest of the world, both passed that threshold a good few years ago.
These upgrades will come with significant up-front costs, which means energy prices will rise as businesses pass these expenses onto consumers.
The price of prioritising energy infrastructure
Ongoing strife in the Middle East and Europe is prompting governments to increase defense spending. In October 2024, the UK announced a nearly £3 billion increase in defense spending for 2025, both for the domestic military and as part of a commitment to NATO. Poland, Italy, Germany and Sweden have all increased their defense budgets too, especially given their proximity to the war in Ukraine. And the US’s defense spending accounted for 68% of NATO’s total military expenditure in 2023. Meanwhile, President Elect Donald Trump is calling for NATO countries to spend at least 5% of GDP on defense when many still aren't at 2%! Geopolitical conflict is leading to higher demand for everything from weapons and vehicles to new military bases. This, along with plumped-up wages for military personnel, also contributes to inflation.
All in all, we seem to be exiting the era of ‘easy money’ that persisted for the better part of 20 years. The evidence points to higher long-term inflation, this time paired with still-high interest rates. And as the economic backdrop changes, so must our manner of investing. In a world with increased defense spending, costly commitments to an evolving energy system and demographically driven wage growth, higher inflation will present significant challenges for traditional 60/40 investment portfolios. Expensive valuations for stocks and lacklustre bond yields suggest the need for deeper diversification across assets and geographies as the sun begins to set on the benign environment of the last 10 years.
Defense spending for an uncertain world
In recent months, investors have taken heart from the fall in inflation around the world towards central banks’ target levels. At first glance, the pain of rate hikes appears to have paid off, with subdued inflation providing gains, prompting central banks to start cutting rates again. But beneath the surface, the structural drivers of long-term inflation are still very much in place. These include increased labour power, a retreat from globalisation, the energy transition and the need for higher defense spending. These inflationary pressures are compounded by shorter-term developments too: Donald Trump’s election victory on the promise of higher tariffs on imports and tax cuts for American businesses; the UK’s expansive Autumn Budget; and political victories for populists and protectionists around the globe. So the bright new dawn of falling inflation may prove short-lived; even in September 2024, the month in which UK inflation fell below that long-desired 2% threshold, more than half (52%) of British households reported that their cost of living had risen in the past month. We may be unlikely to return to the exceptional inflation rates of the recent past; however given the damage that persistent inflation has wreaked upon bond and equity markets in the past, investors would be wise to keep their guards up.
2,3
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
Post-GFC average
Labour power
End of globalisation
Energy transition
Defense spending
Potential structural inflation
2, 3
“The 60/40 doesn’t always work. In certain economic conditions, its effectiveness diminishes markedly”
Stockmarket valuation percentile for 12 long-term measures, plotted from 1970
On a range of metrics, stockmarkets have rarely been more expensive
Source: 31 Aug 2024. Robert Shiller, Kenneth French, World Bank, International Monetary Fund, LSEG Datastream, LSEG Worldscope Fundamentals, Orbis. Percentiles calculated over the full history for each measure. US measures included with dotted lines when they significantly extend the history. Cyclically-adjusted price-earnings ratio uses the average of ten years of inflation-adjusted earnings. US equity risk premium is the cyclically-adjusted earnings to price of equities minus the yield on a 10-year US Treasury note. World equity risk premium is the trailing earnings to price of developed stockmarkets minus a blend of 10-year bond yields for the US (50%), Europe (35%), and Japan (15%). World market cap to GDP calculated using the market capitalisation of developed stockmarkets and the gross domestic product in current USD of high-income countries. Enterprise value measures for developed market non-financial companies. EBITDA is earnings before interest, tax, depreciation, and amortisation.
Contribution to market value and profit* of MSCI World Index
‘Magnificent 7’ versus the ‘Mundane 7’: similar market value, a third of the profits
Magnificent Seven
Mundane Seven
12% of profits
32% of profits
Japan
United Kingdom
Canada
France
Switzerland
Germany
Australia
Apple
Microsoft
NVIDIA
Alphabet
Amazon.com
Meta
Tesla
10-year subsequent real annualised return of a US 60/40 portfolio
The 60/40 has generated excellent real returns recently - but not always
+8%
p.a real returns through 2021
-3%
p.a real returns for a decade
Source: 30 Nov 2024. Robert Shiller, Orbis. 60% S&P 500, 40% 10-year US Treasury.
Source: 30 Sep 2024. MSCI, Orbis. *Represents contribution to MSCI World Index consensus net income estimates for the current fiscal year.
Although the classic portfolio of 60% equities and 40% bonds has delivered a terrific balance of risk and return for investors in recent decades, we believe its future prospects appear far less promising. In the face of shifting market dynamics investors need to adjust their expectations or their portfolios.
There are two main scenarios in which the 60/40 breaks down. The first is when inflation is high. When inflation rises meaningfully above 3%, bonds and equities tend to move in tandem – with inflation curbing the performance of both. Higher inflation and interest rates drive down the prices of bonds already in circulation. Today, rates may be starting to fall, but they’re unlikely to return to the historically low levels of recent years, meaning that bond prices won’t receive the same sort of boost. At the same time, companies face higher input costs and spiralling wage costs, which they may not be able to pass on to customers. And higher prices can cause consumers to reign in their spending. All of that can lead to lower corporate earnings and, consequently, lower stock prices. The second scenario is when economic growth is constrained. When the economy stagnates, so do corporate profits. This tends to depress the stock market. Sluggish growth usually entails lower yields from government bonds. This means that the income available from bonds is unlikely to offset any weakness in equities.
When 60/40 won’t do
While inflation has recently fallen back towards central banks’ targets, it remains high in many economies, with political developments posing the risk of renewed upward pressure. These include Donald Trump’s victory in the US presidential election, with his promise of sweeping trade tariffs; the high-spending budgets announced in the UK and Europe; and the need for greater spending on energy and defence. Meanwhile, growth is lacklustre in many countries outside the US. For investors, this undermines the attractions of the 60/40 model. It also leaves the prospects for future returns looking relatively bleak. After a very strong run, equity markets, particularly in the US, look fully valued. Meanwhile, bond yields are relatively modest. So the returns on offer from a 60/40 approach look distinctly unappealing.
A cautious outlook
But that’s not all. Market concentration poses additional risks. Just 15 years ago, the US accounted for around 50% of the MSCI World index, with the tech sector making up around 10%. Today, those figures are around 74% and 26%, respectively. And this concentration is even narrower than those numbers would suggest. In recent years, equity markets have been led up by the surge in mega-cap US technology stocks – most notably the ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla). As a result, a hefty chunk of global market capitalisation is concentrated in a very few companies: today, the Magnificent Seven represent around 20% of passive global portfolios. So any downturn in their fortunes could have massive consequences for markets at large, and in particular to passive investors who are increasingly exposed to the fortunes of these companies.
The perils of concentration
Lofty valuations pose a further acute risk. Valuations in the market-leading sectors look very full – close to their highest levels since the bursting of the dotcom bubble. If anything alarms investors, these are the sectors most prone to profit-taking and panic selling. If passive funds join in the selling, their biggest sales will be their biggest holdings—the very stocks that led the market over the past decade.
So what should investors do? In our view, they should adjust both their expectations and their portfolios. Rather than leaning on a strategy best suited to the past few decades, investors should consider what will work from today’s starting point. With bond yields middling, equity valuations stretched, and inflation risks rising, the classic 60/40 seems unlikely to repeat its past success. To prepare, investors should aim for true diversification - within asset classes, across asset classes and across investment styles. To achieve genuine diversification, investors should look at active equity approaches– especially those that focus on valuations at a time when the market leaders teeter on precipitous multiples. In an era of tech-fuelled growth, value-oriented stocks have fallen out of of favour, creating a wealth of discounted opportunities for bottom-up, active investors. Investors should also consider inflation-linked bonds, which provide real (i.e. inflation-protected) returns, and corporate bonds, assessed on the same active basis as equities. They can turn to ‘alternatives’ too, including infrastructure assets, which offer relatively inflation-proof cashflows, and gold, which has historically outperformed during periods of low growth. And across all their exposures, investors should diversify by sector, geography and investment style to avoid concentration risk and achieve a better overall balance of risk and return. As night falls on the simpler age in which the 60/40 served its purpose, conditions now demand a more agile approach.
Prepping portfolios for a less certain world
Diversification used to be simple. The ‘60/40’ portfolio – 60% equities and 40% government bonds, often passively invested – was seen as a solution for all seasons. The idea was that equities powered the portfolio with growth when conditions were clement, with bonds providing a safety net when stock markets soured. And historically, the 60/40 portfolio has worked very well. In particular, it prospered over the first two decades of this century – a period characterised by lower interest rates and inflation, subdued labour costs and an absence of global conflict. Falling bond yields created a golden age for the passive 60/40 portfolio in recent decades, as they’ve supported returns and valuations for both bonds and stocks alike. But the 60/40 doesn’t always work. In certain economic conditions, its effectiveness diminishes markedly.
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US price to cyclically-adjusted earnings (from 1900)
US equity risk premium (from 1900)
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World price to earnings (from 1973)
World equity risk premium (from 1973)
World market cap to GDP (from 1973)
World price to book (from 1975)
World price to cash flow (from 1980)
World enterprise value to sales (from 1986)
World enterprise value to EBITDA (from 1986)
World enterprise value to invested capital (from 1986)
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Market value
12%
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(3%)
(6%)
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Past performance is not a guide to future performance and may not be repeated. Investment involves risk. The value of investments may go down as well as up and investors may not get back the amount originally invested. Exchange rates may cause the value of overseas investments to rise or fall. www.quilter.com Please be aware that calls and electronic communications may be recorded for monitoring, regulatory, and training purposes and records are available for at least five years. The WealthSelect Managed Portfolio Service is provided by Quilter Investment Platform Limited and Quilter Life & Pensions Limited. Quilter is the trading name of Quilter Investment Platform Limited, which also provides an Individual Savings Account, Junior ISA, and Collective Investment Account, and Quilter Life & Pensions Limited, which also provides a Collective Retirement Account and Collective Investment Bond. Quilter Investment Platform Limited and Quilter Life & Pensions Limited are registered in England and Wales under numbers 1680071 and 4163431, respectively. Quilter Investment Platform Limited is authorised and regulated by the Financial Conduct Authority under number 165359. Quilter Life & Pensions Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority under number 207977. Registered office: Senator House, 85 Queen Victoria Street, London, United Kingdom, EC4V 4AB. Quilter uses all reasonable skill and care in compiling the information in this communication and in ensuring its accuracy, but no assurances or warranties are given. Investors should not rely on the information in this communication when making investment decisions. Nothing in this communication constitutes advice or a personal recommendation. This communication is for information purposes only and is not an offer or solicitation to buy or sell any Quilter portfolio. Data from third parties is included in this communication and those third parties do not accept any liability for errors and omissions. Investors should read the important information provided by the third parties, which can be found at www.quilter.com/third-party-data. Where this communication contains data from third parties, Quilter cannot guarantee the accuracy, reliability or completeness of the third-party data and accepts no responsibility or liability whatsoever in respect of such data.
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“Despite the normalisation of interest rates to their historical averages over the past couple of years, both the re-election of President Trump and Labour’s financial plan in the UK pose a real risk of significantly higher inflation”
The importance of investing for the long term
Source: Quilter Investors, FactSet as at 31 October 2024. Total return, percentage growth over period 31 October 1994 to 31 October 2024. Based on an initial investment of £10,000. Global equities is represented by the MSCI All Country World Index, global bonds is represented by the Bloomberg Global Aggregate (Hedged) Index, and cash is represented by the UK Base Rate. The information provided is for illustrative purposes only and doesn’t represent the past performance of any particular investment. It is not possible to invest directly into an index.
Chart 2: Net return from savings after inflation
Chart 1: Savings vs inflation
Source: Quilter, ONS and Bank of England as at 27 November 2024. Consumer Price Index annual rate (ONS) and monthly interest rate of UK monetary financial institutions sterling cash ISA deposits (Bank of England) over period 1 January 2013 to 1 January 2023.
Global equities
Global bonds
Cash
The re-election of President Donald Trump and the UK government’s financial plan could put upward pressure on inflation and extend the era of higher-for-longer interest rates. For some, this might seem like good news, offering a chance to manage wealth without taking on investment risk. However, over the long term, traditional savings methods like cash do not fare as well as investing.
Until the last couple of years, inflation had been much lower by historical standards partly due to globalisation, which kept price rises suppressed and resulted in only gradual erosion of savings over time. The charts below illustrate how the erosion gap widened significantly, even as savings rates began to increase. The data compares the Consumer Price Index (CPI) with the average cash ISA rate. It shows that although savers benefited from a sharp rise in the interest on their savings, this gain was more than offset by rising prices during the same period, leading to a much larger erosion gap than many probably realised.
Mind the savings gap
There are numerous reasons why your clients choose to invest, with the primary objective often being to achieve growth that outpaces inflation. This goal can typically be met by adopting a long-term investment horizon and diversifying investments across bonds, equities, property, and alternative asset classes. Diversifying across asset classes with low return correlations helps portfolios be more resilient to market shocks and downturns. Diversification also smooths out returns over a long-term investment horizon, helping your clients reach their financial goals. It’s important to remind your clients that all investments carry inherent risks and can experience volatility, with values fluctuating both up and down, and no guarantees of investment return. This emphasises the importance of a long-term perspective. The ability to withstand market fluctuations and not sell investments prematurely can significantly enhance the likelihood of achieving real returns.
Why invest when interest rates are high?
The chart below shows that over the long term, there is an upward trend of returns from equities and bonds, despite the short-term volatility caused by major events. In fact, a £10,000 investment into global equities in 1994 could have grown to be worth £127,835 today. This is nearly three times more than bonds (£46,879) and over five times more than cash (£24,508).
The benefits of long-term investing
Despite the normalisation of interest rates to their historical averages over the past couple of years, both the re-election of President Trump and Labour’s financial plan in the UK pose a real risk of significantly higher inflation. Political decisions can greatly impact prices, asset values, and interest rates. For those willing to invest over the long term, a multi-asset approach can be particularly beneficial. By spreading investments across a diversified range of asset classes, portfolios can become more resilient to market shocks and downturns. This can offer your clients a better outcome than if they relied solely on savings, even when interest rates are higher.
Conclusion
We have witnessed the extraordinary re-election of President Trump to the White House, with the Republican Party achieving a clean sweep by retaining the US Senate and recapturing the House of Representatives. This strong mandate from the US electorate potentially paves the way for President Trump to pursue the bold promises he made during his campaign, which could trigger future price rises. During his election campaign, President Trump promised to extend personal tax cuts for US citizens and further reduce taxes for US companies. Additionally, he has issued stark warnings to the rest of the world about the possibility of raising existing tariffs or introducing new ones, which would significantly increase costs for exporters to US consumers. These policies would likely lead to much higher inflation than the US Federal Reserve’s 2% target, and more importantly, could have a significant impact on future US interest rates and ultimately US corporate earnings. Meanwhile, the new UK government presented their first budget in the autumn, surprising many with an increase in National Insurance contributions for the private sector. This change could have significant consequences. Businesses will face tough choices about whether to absorb this cost and dent their profits or reduce their workforce over time, increasing unemployment. Alternatively, they could dilute future workforce wage rises, or pass this extra cost on to their customers through higher prices, again putting upward pressure on inflation. So, why are both the US election and the Labour Budget important for savers and investors?
The rise of inflation (again)
Simon Durling, Investment Director
“The transparent structure of an MPS allows advisers and their clients to see the full range of underlying funds, providing an additional level of transparency compared to the FoF approach”
In the world of multi-asset investing, two different investment strategies are often at the front of advisers’ minds when selecting an appropriate solution for their clients: fund of funds and managed portfolio services.
*Source: NextWealth Multi-Asset Distribution Dynamics report, June 2024.
The more traditional approach to multi-manager investing is a FoF. This is an investment strategy where a single fund invests in a diversified selection of other funds. A FoF also offers advantages to suitable clients that can be summarised by the three Ts: toolkit, trades, and tax. A FoF can often access a wider investment toolkit than an MPS. They can invest in a broader universe including assets such as exchange-traded funds, investment trusts, and derivatives, which are not typically available in an MPS. This can help maximise returns and manage risk. The ability of a FoF to make changes and execute trades at a moment’s notice is another benefit. This allows them to quickly take advantage of market events and opportunities as they are not reliant on platform technology. Finally, a FoF does not create a capital gains tax event for an investor when rebalancing, whereas rebalancing an MPS can trigger an event if it’s held unwrapped.
Fund of funds and the three Ts
A FoF is ideal for investors seeking a diversified investment approach with potential tax advantages and efficient trading capabilities. It can also be suitable for those who prefer a hands-off investment strategy with professional management of a broad range of assets. Meanwhile, an MPS is often suitable for investors who value transparency and want to see the specific funds in which they are invested. It can offer flexibility and a wide range of options, making it a good choice for those who require a more personalised investment approach. Both structures can be used effectively in financial planning and are popular options with advisers - 79% use both as part of their investment proposition*. Understanding their differences and benefits can help advisers make informed recommendations that align with their clients' financial objectives.
A suitable approach
Both a fund of funds (FoF) and a managed portfolio service (MPS) are multi-asset investment solutions that offer advisers the opportunity to outsource the asset allocation, fund selection, and ongoing management of their clients' investments. However, they both have unique characteristics and uses in financial planning as well as differing significantly in their structure and operation.
An MPS is a range of investment portfolios built as models, with the underlying funds held directly by the investor. The transparent structure of an MPS allows advisers and their clients to see the full range of underlying funds, providing an additional level of transparency compared to the FoF approach. The investor can see each component of their portfolio, enhancing the perceived value of their investment. An MPS can also offer advisers and their clients substantial optionality when it comes to investment suitability. For example, WealthSelect, Quilter’s MPS, consists of 56 different portfolios managed across eight different risk levels that each target a specific range of volatility. Then, depending on the needs and preference of their clients, advisers can choose to invest in a managed, responsible, or sustainable portfolio. There is also a choice of active, blend, or passive investment management styles. The optionality of an MPS is a significant advantage for advisers. This is particularly important in a post-Consumer Duty world where there is an increased focus on advisers being able to demonstrate that the products and services they provide to their clients are tangibly linked to their needs, goals, and preferences. An MPS also allows advisers to outsource the ongoing management of their clients’ portfolios. An MPS will be rebalanced on a regular basis to keep it in line with its investment objectives but can also be rebalanced at any time to adapt to changing market conditions.
The benefits of an MPS
Andrew Miller, Lead Investment Director
Navigating multi-asset investing: Fund of funds vs managed portfolio service
Find out more about the multi-asset Artemis Monthly Distribution Fund
“It is possible to generate an attractive total return by buying selected dividend-paying equities and then patiently reinvesting the income they pay out, quarter after quarter, year upon year”
Reinvested dividends are an important component of total returns from equities over the long term (growth of $10,000 invested from 1988-2024)
Source: Artemis, LSEG Datastream as at 31 December 2024.
S&P 500 (excluding dividends)
S&P 500 (dividends reinvested)
James Davidson, co-manager of the Artemis Monthly Distribution Fund
1) Don’t underestimate the importance of dividends to long-term returns
After a long bull market in equities, the simple wisdom of Jeremy Siegel’s ‘Stocks for the Long Run’ – that owning equities is the best way to grow your wealth – seems self-evident. At the same time, many investors want an investment strategy that can deliver total returns more smoothly than is possible through a 100% allocation to shares. Traditionally, the simplest way of sheltering your investment portfolio against volatility has been to make a significant allocation to bonds. And while that remains a sound strategy, we would suggest that investors should also consider the role that that income-generating assets such as dividend-paying equities and high-yield bonds can play.
Dividends offer investors two useful things. Perhaps most obviously, they generate an income stream that can grow with inflation. But they also represent a significant proportion of the total return that equity markets have delivered over the long term. That can be easy to overlook, particularly after a decade in which the impressive earnings growth (and multiple expansion) for non-dividend-paying growth stocks has pushed global market indices higher. Look at the S&P 500 index since 1988 and some 55% of the cumulative total return can actually be attributed to reinvested dividends.
2) Owning income-generating assets offers useful protection in down markets
Market history suggests that a simple multi-asset portfolio with its core holdings in corporate bonds and dividend-paying equities provides valuable protection during market sell offs. Consider a portfolio whose assets are evenly split between investment-grade bonds (ICE BofA Global Broad Market Index) and dividend-paying equities (MSCI World High Dividend Yield Index). Such a portfolio would have imposed far smaller losses on investors during major market corrections than a 100% allocation to equities (MSCI World Index). To take just two prominent examples:
3) Short-duration assets can play a part in delivering long-term investment returns
If you own a company’s shares you have a claim on its future cashflows in perpetuity; as a result, equities are inherently ‘long duration’ assets: they are exposed to changes in the discount rate and interest-rate risk. That risk is multiplied if you own growth stocks, the bulk of whose profits are expected to be generated in the distant future. When interest rates were either low or falling, as they were for much of the decade after the financial crisis, adding duration represented a winning strategy. But what if we have moved into a new era for monetary policy? What if geopolitical tension, trade wars and tariffs mean inflation is stickier and more volatile than it was in the recent past? Under these conditions, it may be prudent to make a meaningful allocation to relatively ‘short duration’ assets such as high-yield bonds, which are both less sensitive to interest rate expectations and which currently generate an extremely attractive yield.
A simple, income-focused portfolio can harness the power of compounding to grow wealth over the long term
The future is uncertain. Given that, there may be something to be said for steadily gathering and reinvesting dividends from equities and coupon payments from bonds and then letting compounding slowly work its magic. High-yield bonds and dividend-paying equities may, in relative terms, be ‘short duration’ assets. But that doesn’t mean they are only suitable for short-term investors.
Our perspective is that dividends still have an important role to play in building wealth. It is our experience that it is possible to generate an attractive total return by buying selected dividend-paying equities and then patiently reinvesting the income they pay out, quarter after quarter, year upon year.
During the bursting of the dotcom bubble from 2000-’03 – the maximum drawdown suffered by investors in the income-focused portfolio would have been 12%. But by March 2003, investors with a 100% allocation to global equities would have endured a loss of 49%. In the short Covid-inspired sell-off in March 2020 – investors in the simple income-based portfolio would have seen an 8% fall in the value of their investments. The losses imposed on equity-only portfolio were, at 15%, almost twice as large .
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Sources 1 Source: Bloomberg, Artemis as at 31 December 2023. Index data in GBP, returns calculated peak-to-trough using the price change in a portfolio consisting of a 50% allocation to MSCI World High Dividend Yield and 50% to ICE BofA Global Broad Market Index, rebalanced monthly.
FOR PROFESSIONAL INVESTORS AND/OR QUALIFIED INVESTORS AND/OR FINANCIAL INTERMEDIARIES ONLY. NOT FOR USE WITH OR BY PRIVATE INVESTORS. This is a marketing communication. Before making any final investment decisions, and to understand the investment risks involved, refer to the fund prospectus, available in English, and KIID/KID, available in English and in your local language depending on local country registration, from www.artemisfunds.com or www.fundinfo.com. CAPITAL AT RISK. All financial investments involve taking risk and the value of your investment may go down as well as up. This means your investment is not guaranteed and you may not get back as much as you put in. Any income from the investment is also likely to vary and cannot be guaranteed. Investment in a fund concerns the acquisition of units/shares in the fund and not in the underlying assets of the fund. The fund is an authorised unit trust scheme. For further information, visit www.artemisfunds.com/unittrusts. Any research and analysis in this communication has been obtained by Artemis for its own use. Although this communication is based on sources of information that Artemis believes to be reliable, no guarantee is given as to its accuracy or completeness. Third parties (including FTSE and MSCI) whose data may be included in this document do not accept any liability for errors or omissions. For information, visit www.artemisfunds.com/third-party-data. Issued by Artemis Fund Managers Ltd which is authorised and regulated by the Financial Conduct Authority.
Find out more about the multi-asset Artemis Monthly Distribution Fund.
“The debate shouldn’t be whether or not to invest in the high yield market – but rather where to invest in the high-yield market”
“High-yield bonds are not without risk. But while some risks are well worth the potential reward, there are others you don’t need to take at all”
‘Safer option’
For some time now, we have felt that when investing in the bond market, it has been better to take £1 from yields upfront rather than trying to make money based on what they are likely to look like in 20 to 30 years’ time. Put like that, it sounds obvious. But this sets us apart from much of the fixed income market. Going into 2024, common consensus was that inflation was falling and interest rates (and government bond yields) would follow. On the balance of probabilities, this meant the most lucrative trade appeared to be loading up on duration via long-dated government bonds and waiting for plummeting borrowing costs to send the price of these assets rallying. But this wasn’t how it turned out. While interest rates came down, the fall wasn’t as sharp as had been predicted. Government bonds underperformed, with the US 20yr+ Treasury ETF losing about 8% last year. In contrast, we felt a safer option was to take a selective approach to investing in high-yield bonds with relatively short maturities; in doing so, it was possible to make double-digit returns last year without having to take a major bet on the direction of interest rates.
Sources 1. Bloomberg. 2. Source: ICE BofA Merrill Lynch Global High Yield Constrained Index as at 31 December 2024. 3. Source: ICE BofA US High Yield Index as at 31 December 2023. Note: small = bottom quartile of total face value issuer sizes; medium = 2nd and 3rd quartile of total face value issuer sizes; large = top quartile of total face value issuer sizes.
‘Safer option’ isn’t a phrase you would traditionally associate with high-yield bonds. Surely the reason these bonds offer much higher yields than investment-grade debt is their much higher risk of default? Not necessarily. The high-yield market has changed significantly since the 1990s and early 2000s: the highest-rated bonds (BB) now make up 60% of the total market, while those rated CCC make up just 10% . The reason this is significant is that between 1981 and 2021, data from S&P shows the default rate for BB bonds stood at just 0.6%. This rose to 3.18% for the next grade down, B bonds. A significant jump in relative terms, but it also meant that on an annual basis, 96.82% of issuers in the latter class kept up with their debt repayments. This gap was dwarfed by the difference between B-rated bonds and the rest of the high-yield market sitting below them. On average, more than a quarter (26.55%) of bonds rated CCC or below defaulted in a given year, meaning you were taking on about 50x the default risk in this area than in the highest-rated part of the high-yield market. Therefore, we would argue that the debate shouldn’t be whether or not to invest in the high yield market – but rather where to invest in the high-yield market.
Market inefficiencies
The drastic drop-off in quality between bonds rated B and CCC may sound oversimplistic, but it helps to underscore one of the defining features of high yield: its inefficiency. Taking a genuine global approach highlights another anomaly in this market. International companies often issue two bonds from the same part of the capital structure and with the same maturity, but with different yields depending upon which country they are issued in. Even after the cost of hedging currency movements, it has been possible to earn a couple of extra percentage points more over the past few years by lending to certain companies in euros rather than dollars (and vice versa). This is on a fully currency hedged basis, so really shouldn’t be happening in an efficient market. But by switching in and out of these opportunities as they present themselves, active investors can pick up a consistent stream of excess return. Another inefficiency relates to the size of the issuer. When we refer to large and small issuers, we’re not necessarily talking about large and small companies. A lot of the smaller issuers have earnings in the billions and market caps in the tens of billions, but are classed as smaller issuers simply because they don't use the high-yield market as a significant part of their funding structure. In contrast, the reason why many companies become large issuers is they have been burning through so much cash that they've been forced to borrow lots of money – exactly the kinds of businesses we don't want to lend to. Yet the preference of many high-yield investors to follow the index (whether passively or because they are closet-trackers) means these larger issuers tend to attract most of the analytical attention and capital, leading them to become overpriced. This is why we prefer to focus on their smaller counterparts, which not only tend to outperform, but do so with lower drawdowns during times of crisis .
Higher yields, lower risk
These inefficiencies allow us to make a couple of extra percentage points of yield and return here and there. Therefore, not only do we need to take on less risk in pursuit of our objectives, but higher starting yields mean the prices of our holdings would have to fall further than that of peers invested in ‘safer’ parts of the bond market before our total return turns negative. We admit that other parts of the bond market will deliver better returns if rates are cut aggressively. Yet this outcome is not a foregone conclusion: in early January, a knockout jobs report in the US led to higher rather than lower yields, while the UK’s long-term borrowing costs hit their highest level since 1998. On such occasions, long duration is the last place you want to be. High-yield bonds are not without risk. But while some risks are well worth the potential reward, there are others you don’t need to take at all.
Jack Holmes, co-fund manager of the Artemis Monthly Distribution Fund
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For more information and to find out more, please visit www.bny.com/investments ID 2047205 Exp: 10 July 2025
For more information and to find out more, please visit www.bny.com/investments
“We have moved from many years of low inflation to a period of higher inflation. This means having to think about what this means for the valuation of assets and investment opportunities”
US consumer price index inflation
Source: Bloomberg, 30 September 2024. Based on US Consumer Price Index Inflation.
Core services
Core goods
Food
Energy
US 5yr breakeven inflation
Headline YoY%
Core YoY%
Downside risks: Rising delinquency rates suggest high rates pinching some households
Newly-delinquent loan balance
Source: FRB, FRBNY Consumer Credit Panel/Equifax, Haver Analytics, Deutsche Bank, May 2024.
Credit card balances
Auto loan balances
World avg. 22-32 (108%)
12-22(81%)
11%
203%
63%
124%
36%
86%
129%
67%
97%
365%
72%
62%
US to achieve world's largest rate of growth in fabrication capacity
Global semiconductor capacity increase by location
Source: XSIA, SEMI; BCG analysis, 'Emerging Resilience In The Semiconductor Supply Chain'. May 2024.
2012-22 % change
2022-32F forecast % change
Simon Nichols, Newton mixed assets portfolio manager
The monetary stimulus in developed markets that flooded the system in the years following the global financial crisis has been replaced by fiscal stimulus post the pandemic, which has supported economic growth, particularly in the US. In the US, the Infrastructure Bill, the CHIPS Act, and the Inflation Reduction Act have committed a large amount of money to areas such as infrastructure, technology and the energy transition. We would argue that fiscal stimulus often creates opportunities across supply chains. When it comes to the US, we're thinking about which companies could benefit from manufacturing coming back on shore. Which companies will be involved in building out its infrastructure? Which will supply materials? As bottom-up investors, we try to invest behind where we see fiscal stimulus supporting earnings growth. But we are also aware that fiscal deficits in certain developed market economies are reaching worryingly high levels. This could have implications for bond markets, particularly when coupled with high debt to GDP ratios and the end of quantitative easing (QE). If the US keeps issuing debt, the bond market could start to worry about the government’s ability to continue servicing that debt.
1) From monetary to fiscal stimulus
We've also seen a move away from the globalisation characteristic of the past few decades towards countries moving manufacturing onshore. Rising geopolitical tensions and Covid have highlighted the risk of supply chains being so geographically spread. In the semiconductor space, for example, supply chain dynamics are shifting. In the previous decade, China had the most rapid growth in building semiconductor fabrications but looking forward, the US is expected to take over (see chart below). In fact, the US is forecast to capture about one quarter of the global Capex in the semiconductor supply chain in the next 10 years.
2) From free trade to protectionism
We are living in a world with higher interest rates and thus a higher cost of debt. But this has perhaps been slower than expected to impact consumers and companies given the fact that economies have largely held up better than anticipated. It also typically takes several years of higher interest rates to feed into the cost of debt for companies and households. But in the US economy, in the past couple of years, auto loan and credit card delinquencies have risen to high levels (chart below). It is typically lower income households that have more of this type of debt, and they are starting to feel the pinch of higher interest rates on the cost of living. Additionally, lower income earners have generally seen lower wage rises relative to inflation than other earners.
On the corporate side, we saw a lot of companies issuing debt during Covid. As this debt reprices, we will watch carefully how certain companies cope. For this reason, we favour quality companies with sound fundamentals and attractive valuations that we think stand to benefit from thematic tailwinds.
3) From zero interest rates to higher cost of debt
We have moved from many years of low inflation to a period of higher inflation. This means having to think about what this means for the valuation of assets and investment opportunities. Inflation peaked after Covid due to heightened demand for goods at a time when supply chains were disrupted, compounded by the war in Ukraine. But inflation is likely to remain sticky. As the chart below shows, US consumer price index inflation appears to be driven by core services. We also see the global themes of the energy transition, fiscal spending, onshoring and defence spending keeping the foot on the accelerator of inflation.
4) From disinflation to inflation
When we think about equity valuations against this backdrop, markets have been strong thanks to a handful of companies – the so-called magnificent seven. The consensus narrative now is an economic soft landing and we believe if a recession is avoided, equities look well supported over the longer term. In terms of bonds, as mentioned before, we see potential issues around high fiscal deficits, high debt to GDP ratios and a significant change in the supply and demand dynamics in bond markets with the end of QE. In this changing environment, we argue it helps to be in full control of our multi-asset portfolios. Individual portfolio managers are responsible for constructing our multi-asset portfolios from the bottom-up. They are not funds of funds; they are directly invested portfolios. It's important that when it comes to the multi-asset portfolios, we very much invest for the long term.
Equities and bonds
Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For more information and to find out more, please visit www.bny.com/investments ID 2047205 Exp: 10 March 2025
Liquidity supported equities in past decade
S&P500® Total Return vs. change in Fed balance sheet, indexed to 1
Source: S&P, Newton, 31 December 2024. Returns in US dollars.
S&P 500 Total Return Index (indexed to 1, LHS)
Change in Fed Balance Sheet (indexed to 1, RHS)
Bonds role as a diversifier may be less reliable
Rolling 36-Month correlation S&P 500® vs. 10yr US Treasury note from 2014-2024
Source: S&P, Newton, 31 December 2024.
Rolling 36m Correlation
5-Day Intraday Correlation
“Against a background of high cash rates and lower premiums, an investment approach founded on ever-rising markets and lower interest rates may no longer reliably deliver the returns clients are seeking”
All things considered, the new regime could see financial-market participants face higher volatility and shorter business cycles than they have become accustomed to. Against a background of high cash rates and lower premiums, an investment approach founded on ever-rising markets and lower interest rates may no longer reliably deliver the returns clients are seeking. In anticipation of this, some asset owners have been moving away from a SAA approach in favour of a ‘total portfolio approach’. This is where investment goals are focused less on measuring the performance of individual components versus index-based benchmarks and more on seeking solutions that can contribute to a total portfolio outcome. We believe so-called liquid alternatives could play a key role in a total portfolio approach. Relevant components of liquid alternatives could include:
In a world that is less connected and less stable geopolitically, and delivering greater dispersion of financial market returns across and within asset classes, we believe that liquid, long/short global approaches should start to perform well. They take idiosyncratic risks and offer the prospect of diversification benefits that may be underrepresented in clients’ portfolios today. In fact, many clients had more money allocated to these types of strategies prior to the global financial crisis. As some asset owners have expanded their target allocation to diversifiers and alternative investments, investing in market-neutral, multi-strategy solutions can allow them to gain efficient access to these varied and liquid approaches in a way that we think will be valuable in the new market regime.
Global macro Cross-asset trend/managed futures Commodity, currency and rates alpha Alternative risk premia Equity market neutral Tail-risk hedging
• • • • • •
A new approach for a new era
In the new environment we believe there is a place for both systematic and fundamental multi-asset strategies. At Newton, fundamental and systematic investors have been working together since Newton’s integration of Mellon Investment Corporation’s multi-asset business in 2021. Our fundamental portfolio managers have been able to improve their own models by harnessing the insights from their systematic colleagues. This has allowed greater efficiency to filter through and has given our fundamental portfolio managers more time to focus on new ideas. For our systematic team, having fundamental colleagues highlighting when trends are about to change can help them de-emphasise certain signals, structure portfolios better, and respond more quickly to a change in direction.
Systematic and fundamental
Liquid and flexible alternative strategies could start to play a larger role in multi-asset investors’ asset allocation plans. In a volatile investment environment, these strategies have the potential to provide uncorrelated returns and downside risk management, without the high fees and additional risks typically associated with alternative vehicles. Many current investment approaches are dated. They were devised in the past macroeconomic and market regime – the period between the global financial crisis and the Covid pandemic, in which financial markets were buoyed by ultra-low nominal interest rates and central bank asset purchases. During this time, many asset owners opted for a strategic asset allocation (SAA) approach, choosing passive equities, as well as buy-and-maintain credit strategies. Some boosted their allocation to illiquid assets such as infrastructure, real estate and private equity, seeking diversification benefits and the potential for higher returns than those delivered by traditional markets.
This approach worked well overall. However, as quantitative easing (QE) came to an end the combination of unprecedented fiscal and monetary stimulus in response to the pandemic led to high and persistent inflation, and central banks then aggressively raised interest rates as they sought to contain it. Inflation has declined from its 2022 peak, but structural factors such as high fiscal deficits, ageing workforces and geopolitical fragmentation threaten to keep it high relative to the QE era, potentially limiting the flexibility of central banks. As the QE era has ended perhaps too has the ‘long any risky asset’ strategy. Given high cash rates, we do not expect the current regime to reward equity market beta in the same way as occurred during the QE era. We expect bonds to offer a lower premium, and perhaps more significantly, a less reliable diversification benefit versus equities (see chart below). Clients may also be contending with a significant portion of their assets being tied up in private markets that lack liquidity and may face markdowns.
Mitesh Sheth, Newton multi-asset chief investment officer
Disclaimers Approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited, which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited is incorporated in England & Wales under company number 8138002. Registered office address: 28 Dorset Square, London, NW1 6QG. The information provided in this document is for general informational purposes only and does not constitute financial, investment, or other professional advice. The content is not tailored to the specific investment objectives, financial situation, or needs of any individual. Investors should not rely solely on this information in making investment decisions. We do not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.
Sources 1. www.ft.com 2. www.hartfordfunds.com
“The next decade could be very challenging for those invested solely in passive and/or traditional strategies unless they adjust their portfolios”
International markets are unusually discounted vs the US
Cyclically-adjusted price-to-earnings (CAPE) ratio
Source: 31 Dec 2024. LSEG Datastream, Bloomberg. Uses monthly data. Gold: Gold Bullion LBM (USD per troy ounce). FANGAM index: a market capitalisation weighted total return index of Facebook (Meta), Apple, Netflix, Google (Alphabet), Amazon and Microsoft. For each series data is shown from the start of decade to the peak and for ten years (when available) after the peak.
Source: 31 Dec 2024. Minack Advisors, MSCI, National Bureau for Economic Research. CAPE ratio is based on trailing operational earnings US$ price indicies, with index and cyclically adjusted earnings deflated by US Consumer Price Index. Data shown for the period available.
Emerging Markets
Developed Markets ex-US
US
-61%
-75%
-59%
-57%
Subsequent peak-to-trough decline
MSCI World Materials (30/05/08- 27/02/09)
NASDAQ (29/02/02- 30/09/02)
TOPIX (29/12/89- 30/09/98)
Gold (30/09/80- 28/02/85)
First, markets are more concentrated than ever. While markets have performed well over the past decade, most of the gains have come from a handful of stocks. As a result, indices – and subsequently passive strategies – are now heavily reliant on a small number of mega-cap technology stocks. For example, just 26 stocks account for half the value of the S&P 500 index and 10 stocks make up 37% of the total index . This poses a clear risk for passive investors. Should the fortunes of these mega-cap stocks reverse, passive portfolios could face significant headwinds. Second, valuations – particularly in the US – are circling historic highs, driven by near-record profit margins and expectations of robust earnings growth in 2025. This leaves markets highly vulnerable to a reversal, as even slight disappointments in earnings could trigger sharp declines. Typically, this setup (high market concentration and valuations), doesn’t bode well for the future returns of passive equity strategies. And there’s another issue – when the market turns, history tells us that the most expensive areas fall the fastest and furthest (see table below). We think that the sections of the market that have delivered the best returns over the past 10 years are unlikely to repeat that stellar performance. Instead, we see much more significant downside risk. So, what can passive investors do to balance their portfolios?
Why rising concentration and soaring valuations spell trouble
One approach is to blend passive and active strategies. Unlike their counterparts, active strategies can navigate challenging environments with intent, lending passive portfolios an extra degree of resilience. Passive strategies are inherently vulnerable to turns in sentiment, when they are obliged to sell in lockstep. But active strategies are not forced to sell in the same way. Active managers can buy on conviction when stock prices fall – rather than selling on weakness as market-cap-weighted passive strategies inevitably do. That’s not to say that passive strategies have no place in a portfolio. This is not a zero-sum game; passive has advantages over active when it comes to cost and convenience, and passive strategies can be used as an efficient means of achieving core exposures. Moreover, the performance of passive and active strategies tends to run in cycles, with one approach outperforming the other for some time before the ascendancy reverses . But a combination of active stock-picking and passive core holdings can provide a crucial balance that helps investors to steer their way through challenging and polarised market environments. But that’s just one layer…
Blending active and passive
When they look beyond passive indices, investors should also be thinking about funds and strategies that stand out from the herd and complement their existing holdings/exposure. That way, they can hope to achieve diversification through investment style as well as by asset class. Funds with a distinctive investment approach are less likely to be correlated with generic passive approaches, and investors should be careful to ensure that their managers are taking a genuinely active approach rather than tightly hugging indices with just a nominal active share. The same goes for regional exposures and underlying holdings. While gains have been concentrated in a handful of stocks – leaving limited opportunities for broader outperformance – this also creates an opportunity for active investors who are willing to take the road less travelled. As the US market has continued to attract the bulk of the world’s capital, this sustained demand has led to a historically wide gap between the average US-listed stock and the rest of the world.
Is the active portion truly diversified?
Such a dislocation provides active managers with an opportunity to find overlooked gems with the potential to generate sustainable returns and provide genuine diversification. By adding an active manager who zigs when their passive portfolio zags, investors can reduce the risk and volatility within their overall portfolio. In a world of highly concentrated markets, still-high inflation and heightened correlations, diversification is harder to come by. But achieving appropriate diversification is by no means impossible. By blending active and passive strategies and seeking out opportunities with low correlations to the broad markets and their existing holdings, investors can create portfolios that are more resilient and better balanced – leaving them well positioned to navigate the choppy waters more smoothly.
For years, the debate around active versus passive investing has raged on. And over the past decade, passive strategies have gained popularity thanks to their simplicity, low costs, and strong performance as markets have climbed to record highs. While, for some, this performance has strengthened the case against active investing, it is also a double-edged sword. Markets, like tides, are constantly shifting. Active strategies navigate these shifts with intent, while passive portfolios are bound to the current – leaving them vulnerable to choppier waters. We believe the next decade could be very challenging for those invested solely in passive and/or traditional strategies unless they adjust their portfolios. So, what’s clouding the once-clear waters of passive investing?
Disclaimers Approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited, which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited is incorporated in England & Wales under company number 8138002. Registered office address: 28 Dorset Square, London, NW1 6QG. The information provided in this document is for general informational purposes only and does not constitute financial, investment, or other professional advice. The content is not tailored to the specific investment objectives, financial situation, or needs of any individual. Investors should not rely solely on this information in making investment decisions. We do not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information. The Orbis OEIC Global Equity Fund, Global Balanced Fund and Global Cautious Fund do not have sustainability labels and do not meet the criteria to use a UK sustainable investment label.
Sources 1. commonslibrary.parliament.uk 2. £4.5 billion military boost to Ukraine front line to support UK growth and jobs - GOV.UK 3. Kinder Morgan Touts ‘Enormous Opportunity’ for Natural Gas Exports to Mexico, World
Defence spending by Nato countries in Europe as a % of GDP
Source: Nato. Based on estimated figures for 2024 spending
% of GDP
1.3%
4.1%
Turkiye
Romania
Poland
Italy
Spain
Sweden
Finland
“A robust balance sheet and expansion into new markets, such as mobile gaming and theme parks, should provide further avenues for revenue diversification and resilience”
One of the areas, is defence stocks. The ongoing conflicts in the Middle East and Eastern Europe are driving up defence spending around the world. Last October, for example, the UK government announced that it would increase defence spending by nearly £3 billion in 2025, taking the annual total to £59.8 billion. On top of this, the government has earmarked £3 billion in military aid to Ukraine this year, along with a £1.5 billion defence loan . Defence budgets have also risen in other European countries, including Poland, Italy, Germany and Sweden, with the war in Ukraine a major driver. While US defence spending accounted for 68% of NATO’s total military expenditure in 2023, Donald Trump has called for NATO countries to spend at least 5% of their GDP on defence – although many aren’t even at the 2% level that NATO members have pledged to meet. Strained geopolitics and open war are leading to higher demand for everything from weapons and vehicles to new military bases.
Such market dynamics can often lead to significant dislocations, which in turn create opportunities for those who can think independently and remain focused on company fundamentals. At Orbis, this is where we thrive. So where are we finding opportunities at the moment?
Defence stocks: navigating geopolitical uncertainty
We also see opportunities in energy, where sharps swings in sentiment over the last couple of years have led to volatility and dislocations. It’s no secret that we need to upgrade our critical energy infrastructure, but that’s not going to happen overnight. And renewables come with their own challenges – wind and solar don’t work when the wind isn’t blowing, or when the sun isn’t shining. Compounding this conundrum is increased electricity demand from reshoring, electric vehicles and power-hungry data centres, crucial for artificial intelligence (AI). The age of grids alone would be enough to ensure healthy demand for infrastructure providers, but increased consumption from these sources provides the companies with more ways to win. So, how can we meet energy demands, keep the lights on, and integrate renewables into our ageing energy infrastructure? Natural gas plants make for a pragmatic solution – they emit half the carbon of a comparable coal plant and can be switched on and off quickly to complement wind and solar. As such, we believe companies like Siemens Energy and Kinder Morgan could be well positioned to benefit. Siemens Energy makes gas turbines – vital components in the 100 or so large gas plants built around the world each year. The AI-driven demand for data centres could increase this figure by another 30. It is also a leading manufacturer of electricity transformers, where current wait times stretch to four years. Meanwhile, Kinder Morgan operates North America’s largest pipeline for natural gas and supplies around 50% of the gas exported from the US . Its price-protected or fee-based contracts insulate most of its revenues from inflationary effects and fluctuations in the gas price, while keeping it exposed to any increase in natural gas volumes as a result of rising gas-fuelled power generation or liquefied natural gas exports.
Here, we see opportunities in companies such as BAE Systems, which could be a beneficiary of increased UK defence spending and lingering geopolitical uncertainty . Another example from further afield is Hanwha Aerospace, an artillery specialist that is both a contractor to South Korea’s military and a major player in the country’s massive arms exports. While US contractors provide some of the world’s best kit, they do so at the world’s highest prices. Hanwha has carved out a niche providing quality equipment at a reasonable price, winning it contracts well beyond South Korea. In this role, Hanwha is challenging Western incumbents.
Keeping the lights on (and the data centres running)
While the mega-cap tech stocks have hogged the headlines and delivered the lion’s share of recent returns, many other stocks have lagged behind. In many cases, there are good reasons for this, but we believe some companies that offer decent growth have been overlooked even though they exhibit solid growth prospects, are trading at attractive valuations and have a track record of sustained earnings growth. Two examples come to mind: Taiwan Semiconductor Manufacturing Company (TSMC) and Nintendo. As the world’s leading manufacturer of semiconductors (microchips), TSMC is vital to a vast range of industries, including AI; it has produced chips for Nvidia for three decades. Although demand for semiconductors has rocketed, TSMC’s shares have not kept pace with those of its customers, though it has consistently posted stellar earnings, and its share of the global contract chip market is now roughly 60%--and even higher at the leading edge. Of course, near-term risks, particularly geopolitical tensions between the US and China, are likely to fuel volatility. However, over the long term, we believe the fundamentals remain compelling. Nintendo is another example of a non-US company that has lagged US entertainment peers such as Disney, in part due to concerns over its revenue diversification. Nintendo owns beloved intellectual property like Mario, Zelda, and Pokémon, but unlike Disney, it has been reluctant to monetize its characters outside of video games. That is changing – its 2023 Super Mario Bros Movie was essentially an advertisement that grossed $1.3bn. And unlike many of its gaming peers, Nintendo has historically had limited back compatibility, tools for cross-platform developers, and subscription revenues. Those too are changing. The company’s focus on innovation, evidenced by the success of the Switch and its upcoming successor, positions it well for long-term growth in the gaming industry. Additionally, a robust balance sheet and expansion into new markets, such as mobile gaming and theme parks, should provide further avenues for revenue diversification and resilience. We see plenty of similar opportunities that can be accessed by digging a little deeper. The market’s extreme concentration in a small number of highly valued stocks means that there is plenty of value out there – for those who are willing to look.
Mind the GARP (growth at a reasonable price)
They say history doesn’t repeat itself, but it often rhymes. Today’s stockmarket valuations, based on a range of measures, look a lot like the Nifty Fifty era – a time when prices soared, driven by a handful of growth stocks. The spotlight on these US mega-cap stocks has been so intense that it has overshadowed many high-quality businesses, even within the US market itself. Yet, the most striking disparity lies not within the US, but between US stocks and those in other countries. As the US market has continued to attract the bulk of the world’s capital, this sustained demand has led to a historically wide gap between the average US-listed stock and the rest of the world.
Investment involves risk. The value of investments may go down as well as up and investors may not get back the amount originally invested. This communication is issued by Quilter Investors, a trading name of Quilter Investors Limited. Quilter Investors is registered in England and Wales under number 04227837 and is authorised and regulated by the Financial Conduct Authority (FCA) under number 208543. Registered office: Senator House, 85 Queen Victoria Street, London, United Kingdom, EC4V 4AB. This communication is for information purposes only. Quilter Investors uses all reasonable skill and care in compiling the information in this communication and in ensuring its accuracy, but no assurances or warranties are given. Investors should not rely on the information in this communication when making investment decisions. Nothing in this communication constitutes advice or a personal recommendation. This communication is for information purposes only and is not an offer or solicitation to buy or sell any Quilter Investors portfolio or fund. Any opinions expressed in this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or companies within the same group as Quilter Investors as a result of using different assumptions and criteria. Data from third parties is included in this communication and those third parties do not accept any liability for errors and omissions. Investors should read the important information provided by the third parties, which can be found at www.quilter.com/third-party-data. Where this communication contains data from third parties, Quilter Investors cannot guarantee the accuracy, reliability or completeness of the third-party data and accepts no responsibility or liability whatsoever in respect of such data.
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“These solutions can hit the ‘sweet spot’ - not only in terms of their pricing point, but also by combining the best of active and passive”
Magnificent Seven driving returns
Contribution of Magnificent Seven to market returns in 2024
Source: Quilter Investors and LSEG Datastream as at 31 December 2024. Total return, percentage growth, US dollars, rounded to one decimal place over period 31 December 2023 to 31 December 2024 of Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla), the MSCI USA Index excluding magnificent seven, and the MSCI USA Index. Rebased in January 2024.
US equities excl. Magnificent Seven
US equities
Creating a blended investment portfolio can be likened to a chef creating their signature dish. Both require a deep understanding of the ingredients and techniques needed to deliver the right end result.
*Source: MSCI and Morningstar as at 31 December 2024.
It all boils down to realising the benefits of both active and passive. Take the current market dominance of the Magnificent Seven as a topical example. The surge in performance from this group of US mega-cap tech stocks has been a prevalent investment theme over the last two years.
Boiling down the benefits
Staying with the theme of the Magnificent Seven, we now have a heavily concentrated US equity market with incredibly high valuations. To put this into context, the US market makes up 67% of the MSCI All Country World Index, with the Magnificent Seven holding a higher weighting than the next seven countries combined*. This means that certain passive strategies are heavily weighted towards a small subset of mega-cap tech companies. With the global geopolitical temperature rising against an uncertain investment backdrop, this could be a concern. The advantage for active strategies in this environment is having the ability to navigate away from this turbulence if required, whilst at the same time identifying other opportunities outside of this expensive group of stocks.
Balancing the flavours
To construct a blended portfolio, a portfolio manager needs to consider how much of each ingredient to use, just like a chef when writing their recipe. A portfolio manager should start with a solid base through a long-term strategic asset allocation to maximise risk-adjusted returns over time. Like fine cuisine, blended portfolios can also benefit from the expertise of the professional crafting them. In a blended portfolio this can take the form of a tactical overlay to maximise short-term opportunities and implement investment conviction over three-to-six-month periods. The flexibility to be able to adjust the flavour of the portfolio by adding a dash of a particular asset, or less of a specific asset, is key.
Finding the perfect recipe
Once the recipe is written the best dishes need the best ingredients. Selecting the right managers within a blended portfolio is no different. No one manager can be an expert at everything all the time so it’s about finding the best managers in each area through an in-depth manager selection and due diligence process. Mixing ingredients from across a wide range of asset classes, market sectors, and geographies can then help capture the upside whilst also helping to dilute any potential downside. Having the ability to apply active management techniques can also introduce further flexibility and opportunity. For example, the portfolio isn’t just concentrated in areas where passive portfolios are obliged to invest.
Selecting the best ingredients
Whether you’re a blended portfolio manager or a master chef, generating the right outcome is a skilled art. By carefully blending the different investment techniques and approaches, blended portfolios can provide your clients with the right mix of resilience and opportunity in a cost-efficient way.
The result
Passive strategies have benefited from the fact that these companies have become larger in traditional market-cap weighted indices. Active strategies, seeking exposure to US large-cap equities, have found it difficult to own enough of these stocks, resulting in a significant difference in relative performance. So, the case for passive in the example of the Magnificent Seven is clear: it provides a clear and cost-effective way to access and track certain investment markets. However, the benefit of a blended portfolio is that it can use the appropriate passive strategies whilst also using the flexibility and subtlety of active management techniques to better manage risks and make the most of other opportunities as they arise.
A blended investment portfolio isn’t just about throwing some active and passive funds together and hoping for the best. Like a chef, a portfolio manager must achieve the right mix to deliver a good outcome. This involves selecting the right fund managers, mixing different investment styles, and making the tactical adjustments to create an expertly-crafted portfolio. In this post-Consumer Duty world, blended portfolios have surged in popularity. These solutions can hit the ‘sweet spot’ - not only in terms of their pricing point, but also by combining the best of active and passive.
Finding the right mix
Ryan Medlock, Investment Director
5 September Truss elected
23 September Mini-budget
12 October Position taken
25 October Truss leaves office
Source: Quilter Investors and Morningstar as at 31 July 2024. Total return, percentage growth, rebased to 100, rounded to one decimal place of the ICE BofA UK Gilt Index over period 1 September 2022 to 31 October 2022.
Return (rebased to 100)
UK gilts – September 2022 mini-budget
“What is different about the market outlooks for 2025 is the broad consensus amongst many managers. In simple terms, most are identifying the US as the best equity market to invest in over the year – and Europe as the worst”
Investment outlooks for 2025 share an unusual level of consensus, but how reliable are such forecasts? Andrew Miller, Lead Investment Director at Quilter Investors, explores the role of multi-asset investing in uncertain markets.
Which equity region will perform the best and worst in 2025?
Source: Quilter Investor Trend Survey Q4 2024, November 2024.
Europe 40%
Japan 20%
China 13%
UK 13%
EM 7%
US 7%
Worst
US 41%
China 18%
Japan 18%
Europe 6%
UK 12%
EM 6%
Best
This view that the US will lead the way is entirely logical – and we are reasonably well-aligned to it. The US boasts a relatively buoyant economy and some of the world’s most innovative and successful businesses. In addition, a ‘business friendly’ president who focuses on the stock market as a measure of his success, only adds credence to this view. Europe, on the other hand, faces political turmoil. There is government instability in France, Germany, and Austria. Meanwhile, businesses in Europe are often viewed as a little stale – leading a former Secretary of the US Treasury to describe Europe as a ‘museum’. And of course, the potential prospect of Trump’s tariffs does not help.
US out in front and the ‘museum’ of Europe
So, if the outlook is as binary as this - what is the point of multi-asset investing? Based on the evidence at hand, perhaps you should have no exposure to Europe and bet it all on a US growth fund? That approach would certainly have served you well over the last 12 months. But let’s look at the consensus across investment outlooks from the last five years. How did they play out? Well, in 2020, coronavirus meant that predictions were meaningless by the end of the first quarter. In 2021, very few anticipated the enormous rise in inflation, which was described as ‘transitory, until it was clear it wasn’t. In 2022, aggressive hikes in interest rates caught markets off guard, leading to the worst year for fixed income on record. In 2023, there was a widely predicted US recession that never happened. And in 2024, very few expected the extraordinarily positive returns from US equities. So, every year for the last five years, clever people have made sensible, reasonable, and logical predictions about the year ahead. And every year they have been wrong.
With the US tipped to win, why diversify?
So, what we can predict with absolute certainty for 2025? That forecasts won’t be 100% right. Unexpected events will happen, which will have a knock-on impact on markets. And that is where multi-asset investing comes into play. The secret is to find a multi-asset investment solution that gets it right more than wrong. That doesn’t sound too hard – and yet many multi-asset investment managers provide returns that can be disappointing relative to the broader market. So, what should you look for? We believe it is about having the right approach:
Begin with a sensible view of the most appropriate asset mix for a given level of risk. This involves looking at the potential returns from each investment area, the associated risks, and how each investment area correlates with the others. That provides a solid starting point. The next step is to consider the economic landscape, market environment, and political temperature. Then, to alter exposures accordingly based on the short-term impacts. Third, combine these views and diversify investments across geographies, asset classes, and management styles to create portfolios that are managed to the required level of risk. Then, you need to regularly rebalance and update the portfolios, considering anything that may have changed from the first three steps.
1. 2. 3. 4.
The only sure bet: expect the unexpected
However, you must also be prepared for the unexpected and react quickly. An example is our response following Liz Truss’s ‘mini budget’ in 2022. The £45bn of unfunded tax cuts it contained led to drastic falls in gilt prices (increasing yields). Following the mini budget, the Bank of England made a statement to calm investors, and the portfolio managers of our Cirilium Blend Portfolios were able to act swiftly. They purchased an index-linked gilt ETF that captured the recovery in the price of index-linked gilts. Over the course of just two days, this position increased in value by more than 20%. Overall, this was a relatively small position in the portfolios, but still had a positive effect on the Cirilium Blend Portfolios in what was a very difficult year to be invested.
Reacting to the unpredictable
Finally, multi-asset investing is about staying humble. That means you accept that you may not always get it right, you are prepared to learn from your mistakes, and you adapt your approach accordingly. It’s this wisdom, informed by learned experience and continuous review and analysis, which can make multi-asset investing a good choice in all market conditions.
Staying humble
The start of a new year brings with it many traditions. From ‘first footing’ in my native Scotland, to hanging up onions around your door in Greece, to wearing new yellow underwear in Peru. Many fund groups also have their own tradition, which involves publishing their thoughts on the investment opportunities and risks that may occur in the year ahead.
However, what is different about the market outlooks for 2025 is the broad consensus amongst many managers. In simple terms, most are identifying the US as the best equity market to invest in over the year – and Europe as the worst.
A broad consensus
