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Cirilium Blend Commentary - May 2022

UK: Suitable for retail and professional clients.

Date: 28 June 2022

Market review

In May, signs of a shift in investor focus, away from worries about inflation and the rising interest rates needed to combat it and toward the weaker outlook for economic growth, led to a pause in the sustained equity and bond market sell-off that has so far characterised 2022.

Among equity markets, UK large cap stocks were again strong performers. The energy sector led the way, as oil prices rose, despite a 25% windfall tax on oil and gas company profits announced by the UK government, which subsequently impacted the shares of energy generators such as Drax and Centrica.

While the FTSE 100 Index gained 1.1%, the UK’s smaller companies didn’t fare so well, with the FTSE 250 Index declining by an identical amount.

Elsewhere, the MSCI Japan Index gained 1.3%, thanks partly to a recovery in the yen after two months of heavy losses.

Returns were muted but each portfolio outperformed its comparator

Meanwhile, emerging market equities were helped by the easing of pandemic restrictions in China. The country has pursued a ‘zero covid’ strategy this year resulting in much of Shanghai being placed in lockdown. Consequently, the MSCI Emerging Market Index was up 0.1% while the MSCI China Index gained 0.8%.

The MSCI USA Index finished the period down 0.6% with the consumer staples sector being a notable casualty. This was largely driven by corporate earnings releases from some major US retailers, some of which announced reduced profit margins.

In Europe, much stronger-than-expected eurozone inflation data at the end of the month re-ignited the bond market sell-off, although European equities mostly held their ground with the MSCI Europe ex UK Index down just 0.3%.

At its May meeting, the US Federal Reserve (Fed) confirmed that in June it will begin to sell the assets it purchased under its pandemic-era quantitative easing (QE) programme, meaning that quantitative tightening (QT) will get underway. It also raised its policy rate by 0.5%, double the usual 0.25% increment.

April’s consumer price index report (released in May) showed tentative signs that US inflation may be peaking with the headline rate dipping from 8.5% to 8.3%.

Signs that inflation may be peaking, and that the subsequent rate of interest-rate increases might slow, helped US Treasury yields to fall (meaning their prices rose), while global equity markets regained their poise and rallied in the closing weeks of the month with the MSCI World Index down just 0.2%.

The Bank of England (BoE) raised UK interest rates by another 0.25%, at its May meeting, to 1%. Having been among the first of the developed market central banks to increase interest rates, the BoE has so far been unwilling to ramp up the pace of tightening, despite increasingly rampant inflation, due to a particularly weak growth outlook. Monthly UK GDP growth for March was down 0.1%.

Over the month, the ICE BofA UK Gilt Index declined 3.1%, while the ICE BofA Sterling Corporate Index also fell, down 1.6%. However, US Treasuries posted a small gain, with the ICE BofA US Treasury (sterling hedged) index nudging up 0.1%.

* Currency hedging of foreign investments dampens the effect of currency fluctuations on returns and reduces the volatility of your investment. Under most circumstances, we currency hedge foreign currency bond holdings, except in cases where the foreign currency exposure is an explicit return-driver (eg emerging market local-currency debt exposures).
(All performance figures in sterling terms and rounded to one decimal point, unless otherwise stated.)

Performance review

The Cirilium Blend portfolios delivered muted returns in May. These ranged from marginally positive returns for the two lower-risk portfolios, to marginal losses for the three higher-risk portfolios. Notably, each of the portfolios outperformed their respective Investment Association (IA) sector comparators. The performance of each Cirilium Blend portfolio and its respective IA comparator is listed below.

In May, the Cirilium Conservative Blend Portfolio gained 0.03% while its IA Mixed Investment 0-35% Shares sector comparator declined 0.8%; the Cirilium Balanced Blend Portfolio gained 0.01% while its IA Mixed Investment 20-60% Shares sector comparator fell 0.6%; the Cirilium Moderate Blend Portfolio declined 0.1% against its IA Mixed Investment 40-85% Shares sector comparator, which fell 0.9%; the Cirilium Dynamic Blend Portfolio declined 0.1% while its IA Flexible Investment sector comparator fell 0.9%; and the Cirilium Adventurous Blend Portfolio declined 0.2% against its IA Flexible Investment sector comparator, which fell 0.9%.

The best-performing holdings were ‘value’ strategies

Overall, global equities fell 0.2% in May according to the MSCI World Index while global bonds, in aggregate, retreated slightly less. Within this, UK equities were again among the standout performers with the FTSE 100 Index delivering 1.1% as it continued to benefit from its high exposure to commodity-related companies.

Once again, the portfolios’ best performers were ‘value’ oriented. This was partly a reflection of the ongoing struggles for ‘growth’ companies in May, which included a backdrop of rising interest rates and the sudden decline in revenue and earnings growth that many of the ‘pandemic winners’ are now seeing after delivering record numbers in recent years.

The two standout equity performers in the Cirilium Blend portfolios were the iShares Edge MSCI Europe Value Factor ETF, which gained 4.5%, and the JO Hambro UK Dynamic Fund, which added 2.7%.

The worst performers in May were the Sands Capital US Select Growth Fund and the Montanaro UK Income Fund. Both funds tilt towards high-growth companies and, partly as a result, they declined by 8.5% and 3.8% respectively.

Among our alternatives holdings, the best performer was the Cooper Creek North American Long Short Equity Fund, which continued its strong 2022 performance with a gain of 2.9%, to be ahead 20.8% in the first five months of 2022.

During the month, we exited the Usonian Japan Value Fund. We re-invested the proceeds into the M&G Japan Fund, doubling our existing position, as we have a higher level of conviction that the team at M&G will outperform over the medium term. Elsewhere, we exited an overweight position in Australian government bonds and an underweight to UK gilts, relative to our strategic asset allocation (SAA) model, for a small loss.

Our equity weightings remained unchanged in May; they reflect a modest overweight compared to our long-term SAA model. Within this we are slightly underweight to Europe and overweight to global healthcare.

Similarly, we remain slightly underweight bonds as we expect bond prices to fall further from here. We are modestly overweight to emerging market bonds and underweight to high-quality bonds, which makes the portfolios less sensitive to interest-rate changes than many of their peers.

Outlook

High inflation and rising interest rates are very damaging to bond markets. For equities, such conditions can be a positive as company revenues should rise in line with inflation. However, because their costs will also be increasing more quickly, the impact on profitability is uncertain.

Rising interest rates also reduce the present value of a company’s future earnings. This has impacted the recent valuations of technology and renewable energy stocks, which had previously performed well thanks to the forecast strength of such future earnings.

The worst-performing holding were ‘growth’ strategies

Even so, at a high level, we think consumers will remain resilient and that this resilience will support company earnings. Consequently, we’re less concerned as to the prospect of a global recession than many others.

That said, the economic backdrop in Europe is perilous given its need for Russian energy and reliance on exports, especially to China. Consequently, it wouldn’t be a surprise to see Europe tip into recession in the coming months. We also question how long China’s ‘zero-covid’ policy and rolling lockdowns can persist in the face of its leadership’s high-growth ambitions.

With all this in mind, we continue to expect muted market returns, with equities still looking more attractive than bonds. Meanwhile, we retain enough cash to take advantage of bouts of market weakness.

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Ian Jensen-Humphreys

Portfolio Manager

Sacha Chorley

Portfolio Manager

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