The big news of the month was the election of Donald Trump as 45th president of the United States of America which world equity markets ultimately responded well to when viewed in local currencies. Bonds, however, generally fell in price as whilst Trump’s spending plans are likely to spur short to medium term growth they look likely to radically increase the fiscal deficit and push up inflation. For UK investors, after a tough post EU referendum period, the pound strengthened strongly in November which put pressure on the returns of overseas assets when converted back to sterling.
In the US, equity markets recovered quickly from their immediate falls on the news of Trump’s win, powering ahead on the prospects of increased infrastructure spending and lower taxes. As mentioned, bonds fell on the same news. With unemployment low, fiscal stimulus increases the chances of monetary tightening in the US. The chance of a rate rise in December is now priced in as almost certain.
In the UK, the pound strengthened on generally positive economic data and market perceptions of reduced risk of a hard Brexit. Part of this was the due to the government losing its High Court case that it could invoke article 50 to leave the EU without the scrutiny of a parliamentary vote. The government is appealing this decision at the Supreme Court. Philip Hammond delivered his first Autumn Statement as chancellor, unveiling a new infrastructure plan that should boost GDP by 0.4% a year over the next five years. There was also a focus on boosting UK productivity growth, which has lagged many other developed economies since the financial crisis.
In mainland Europe, somewhat surprisingly Francois Fillon was selected as the Republican candidate for next April’s French presidential election over Nicolas Sarkozy and Alain Juppe. This was taken as positive by the markets as Fillon is popular with conservatives and is seen as likely to be able to defeat Eurosceptic Marine Le Pen of the National Front, who has threatened a French referendum on membership of the EU, a risky prospect for markets.
It was a grim month for Emerging Markets over fears Trump will fulfil his promise to throw up trade tariffs on certain US imports (negative for EM exporters to the US). In addition, the likelihood of higher US rates is pushing up the dollar which is generally negative for EM economies and markets. Mexico, in particular, was hit hard as the peso tumbled in the wake of Trump’s election.
Although the press was full of tales of a strong dollar after Trump’s victory, sterling was actually the strongest performing major currency, rising 2.3% against the US dollar, 5.8% against the euro, 11% against the yen, 6.5% against the rand and 9.3% against the Brazilian real.
Currency was again the main driver for the month, as the stronger pound dragged largely positive local currency returns on foreign equities negative. The exception to this was US equities which rallied strongly enough that even though the pound strengthened against the dollar, returns were still positive. Commodities were also slightly positive on a better outlook for global growth and a planned increase in US infrastructure investment.
Government bond yields continued their recent rise for the reasons mentioned above. This lead to a general fall in bond prices with EM debt particularly hard hit as worried investors abandoned the asset class.
FCA Fund Review
The FCA’s Asset Management Market Study Interim Report has just landed on PortfolioMetrix’s desk, all 200 odd pages of it. As the name suggests, this reports details the FCA’s research into the UK’s asset management sector to see if it’s working well in the sense of offering consumers (clients) value for money.
Whilst we haven’t finished digesting the report fully yet, the key result highlighted by the FCA is that overall active management doesn’t seem to be adding value – active managers charge more than passive managers and whilst some add a lot of value and others don’t, in aggregate they do not outperform.
This is a problem from the FCA’s (and society in general’s) perspective as it means the market for active management is not working particularly well. Or to put it another way, the market for active funds is inefficient.
However, whilst an inefficient market is sub-optimal from a societal point of view, this is actually an extremely good thing for the diligent fund selectors active in that market who have both the tools and expertise to perform rigorous fund research. Selectors like PortfolioMetrix.
The reason for this is very simple. Using a poker analogy, if you are a good poker player and you find yourself in game with other great players then, whilst any spectators get to watch a thrilling match, for the players themselves it’s pretty tough to win. It takes a great deal of blood, sweat and tears to eventually claw your way to the top as your competitors are hardworking, smart and trying desperately to do the same. Such ‘efficient’ games are great for the spectators, but hellish for the competitors. This is a bit like what the passive market is like in the UK (although we’d argue not completely – there are still plenty of inefficiencies in even the market for index funds).
Alternatively, if you’re a good poker player and you find yourself lined up against a hodge-podge of inexperienced and inept players (some of whom don’t even understand the rules properly) then the actual gameplay is going to be pretty ragged. Not great from a spectator point of view, but on the plus side unless you’re really, really unlucky, you’re likely to find yourself in possession of a lot of chips in the long run.
From first reading, it seems that the FCA has identified the active asset management market in the UK as more like the second game I describe above rather than the first. It’s absolutely right for the FCA to focus on this as it’s their job to protect consumers. From our perspective though, given that we think we’re one of the good ‘players’, finding out we’re playing in an inefficient market is great news. It means we should be able to add a great deal of value for our clients, as well as helping to raise the general level of the game.
Global bond yields, after a pretty spectacular fall over the previous two years, have been picking up since August. In the UK this has been mainly a function of the economy performing much better than expected since the EU referendum but has also reflected a more positive environment for growth globally.
Yields in the US were generally rising even before the election, and were turbocharged by the election of Donald Trump. His plans for infrastructure spending as well as his plans for tax cuts on the positive side are fairly pro-growth but on the negative side are likely to massively increase the US’s fiscal deficit and lead to higher inflation (and thus tighter monetary policy from the US Federal Reserve). Unfortunately for bond investors, more growth, higher deficits and higher inflation are all negative for bond prices and yields have almost retraced to their highs of 2015 (see below).
Whilst the past few months have been difficult for bond investors, they certainly haven’t been disastrous, particularly for investors who are well diversified across maturities and invested globally.
The below chart and table of some of the fixed income index funds offered by Vanguard again demonstrate the importance of diversification and the advantages of controlling risk through shortening duration. When it comes to controlling downside risk, which is crucial for lower risk clients where we tend to use the most bonds, we use the Global Bond and Short Term Investment Grade Bond fund, rather than standalone UK or US versions.
Bonds do fulfil a useful role in the portfolio if used carefully (diversification again) – it’s certainly not the time to abandon the asset class entirely.
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