News-wise it was an eventful month with the UK formally triggering Article 50 to begin the process of leaving the EU, the withdrawal of Trump’s healthcare bill, the US Fed raising rates by 0.25% and the Netherland’s avoiding the election of far-right candidate Geert Wilders.
PortfolioMetrix have just completed a formal asset allocation review for all portfolios, the results of which have just been implemented in their latest rebalance. How they decide on this asset allocation is reasonably technical, which they have already covered (the perhaps infamous ‘Black Litterman’ discussion), but they did want to highlight one key element of the process: PortfolioMetrix asset allocations are forward-looking, not backward-looking.
In the UK, the early part of the month was dominated by the Spring Budget with Chancellor Philip Hammond revealing a stronger-than-expected economy alongside a controversial increase in National Insurance contributions for the self-employed. This increase, which apparently broke a manifesto pledge, was subsequently scrapped due to resistance from Conservative back-benchers. In response to the Brexit vote and the apparent ‘hard Brexit’ negotiating line of Westminster, Scotland’s First Minister formally requested a second referendum on Scottish Independence which Westminster refused for the foreseeable future. And on the 29th of March Prime Minister Theresa May triggered Article 50 of the Lisbon Treaty.
In the US, equity prices wobbled when President Trump’s health care plans failed to gain sufficient support, raising fears about his administration’s ability to enact eagerly anticipated tax reforms and infrastructure spending. The White House’s ‘hard power’ budget, focusing on increased spending on defence and on the controversial wall planned for the US/Mexican border, funded by cutting environment and State Department spending, also received a lukewarm response. Mid-month, the US Federal Reserve raised its key interest rate by 0.25% to a range of 0.75%-1%, a move widely expected by investors and positively received by markets.
In Europe, incumbent Dutch Prime Minister Mark Rutte saw off a challenge from controversial far-right candidate Geert Wilders in the Netherlands’ General Election. In France, Presidential candidate Francoise Fillon was formerly placed under investigation over allegations of financial impropriety. Moving away from the politics, European economic data was very positive with business surveys having risen to five year highs and consumer confidence nearly at pre-crisis levels. European equities responded well to the positive sentiment.
In March, the pound strengthened against the dollar (up 0.5%), yen (up 0.1%), Australian dollar (up 1.3%), South African rand (up 3%) and Brazilian real (up 2.6%). It did, however, weaken slightly against the euro, down 0.2%.
European equities were the star performer for March, with EM and developed Asian equities also doing well.
Commodities, however, fell quite sharply on the back of lower oil prices.
Interest rate sensitive asset classes also performed poorly, particularly Global Property which also suffered on the back of a weaker dollar (the bulk of exposure is unhedged exposure to US properties).
The FTSE 250 slightly outperformed the FTSE 100 over the month, up 1.4% to the FTSE 100’s 1.1% (the below table shows the performance of the FTSE All Share).
Asset Allocation – Eyes Forward
Faced with an uncertain future, we human beings often cling to the past. In investments, this manifests itself in a desire to buy assets that have performed well previously and to take immense comfort in back-tests. This is often referred to as driving by looking in the rear view mirror, and is just as dangerous.
Below is a graph of the performance of the various equity asset classes we use and listed property over the period covering now and the inception of our UK portfolios (all translated back into sterling).
US equities have been the stand-out performer of the bunch and EM equities have been the clear laggards. If we’re taking a purely backward looking point of view we should be filling our (clients’) boots with American stocks and steering clear of developing markets. Psychologically this is the easy option, but like many easy options it isn’t the right one.
We’re interested not in constructing a portfolio that would have performed best over the past almost 5 years, but rather in constructing a portfolio that will perform best in the next 5 years. And asset that outperform over long periods of time tend to do so by becoming expensive (and vice versa for assets that have underperformed). They then tend to mean-revert to long-term averages, causing backward looking asset allocations to perform poorly over the long-term.
Thus it should come to no great surprise that, relative to MSCI weightings, PortfolioMetrix is currently underweight US Equities and over-weight EM equities. Our desire for diversification means we never take extreme views (like holding no US equities) and we certainly do study the past for valuable insights, but we very much focus on building sensible portfolios that we think will do well in in the future.
After all, whilst it does make sense when driving to glance in the rear-view mirror occasionally, it’s important to focus one’s eyes firmly on the road ahead.
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