Brexit bounce

Simon Doyle, Head of Fixed Income and Multi Asset, summarises the major market movers in July and how our objective based strategy is positioned.


Simon Doyle

Simon Doyle

Head of Fixed Income & Multi-Asset

In July, the biggest contributors to returns were equities with solid gains recorded in most markets. Gains were led by Japan (+6.4%) and Australia (+6.3%), with solid, albeit more modest gains in the US (+3.6%), Europe (+4.4%) and Emerging Markets (+4.7%). Consistent with this, credit performed well with spreads narrowing across the global credit spectrum. These outsized gains in risk assets in July can, in large part, be attributed to the continued accommodation of central banks, with the “shock” of the UK’s Brexit vote providing yet another reason for the Fed to defer raising rates and for the ECB to provide additional stimulus.

While we see reasonable return prospects from Australian, UK and Japanese equity markets, the US still looks challenging on a 3 year view. Our prospective returns for the US are now around 3.5% p.a, implying a narrow risk premium and insufficient in our view for a material exposure. While over time markets can decouple, this will nonetheless be a key influence on the outright performance of global equity markets and a significant factor behind our relative modest total equity exposure.

Concerns about sovereign bond valuations are important in that they offer poor prospective returns and high risk of loss (except under deflation which is in effect the only reason we still hold duration). Low yields also mean our ability to diversify a higher equity exposure is reduced and another reason why our overall equity exposure is modest.

While we are carrying some additional risk in global high yield credit and subordinated debt securities, spreads are narrowing and this is a position we are likely to reduce over time if this trend continues.

In the absence of a better alternative we favour cash. While returns are low, they are both positive and certain (at least in the short term) and compare more than favourably to sovereign bonds (both with respect to yields and return forecasts). In the event that equities fall to re-instate a more appropriate risk premium (especially in the US), a small positive return from holding cash is preferred to a bigger drawdown from equities. We also like cash for its option value as it preserves capital and places us in the best possible position to take advantage of market dislocations.

At a more granular level we have made some modest changes to the Portfolio. We have trimmed the global high yield exposure as spreads have narrowed and slightly reduced portfolio duration against a backdrop of record low bond yields.

The full portfolio commentary can be found in the Monthly Report due out around the 12th business day on our website:

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