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Caerus Select Commentary - July 2021

UK: Suitable for retail and professional clients.

Date: 25 August 2021

Market review

Returns from global equities were modestly positive in July but were weighed down by market jitters in Asia following a regulatory clampdown by Beijing on the technology sector, among others.

Global markets were buoyed slightly by the positive performance of UK, European and US equities. However, this masked a fairly volatile month for global equities, as the continued reopening of economies was marred by rising cases of the Delta variant.

In the UK, England reached the fourth and final stage of the government’s ‘roadmap’ out of lockdown, with 19 July marking the date on which most remaining restrictions were lifted, dubbed ‘Freedom Day’. However, equities were nervy, and UK markets initially fell on opening. For the month, the Investment Association (IA) UK All Companies sector produced an average return of 1.3%.

It was a mixed month for equities, developed markets ended higher, but emerging markets and Asian equities struggled

The Chinese equity market was the worst-performing of the major markets over the month in sterling terms, contributing to emerging market indices approaching ‘correction territory’ – when an index falls by 10% or more. A move by Chinese regulators to step up their oversight of certain sectors, including education, technology and food delivery services, prompted stocks in these sectors to tumble, the repercussions of which were felt in emerging market economies as well.

The IA China/Greater China sector lost an average of 11.2%, while the IA Global Emerging Markets sector fell an average of 5.8%.

Europe’s vaccine roll-out overtook America’s efforts during the month, but European equities failed to outperform US stocks. The IA Europe ex UK sector delivered an average return of 1.6%, slightly ahead of the IA North America sector average of 1.3%. Mixed European economic data, especially out of Germany, resulted in choppy stock markets.

European and US central banks maintained their supportive monetary policies. The European Central Bank held interest rates steady and confirmed the monthly pace of its asset purchase programme would remain unchanged at €20bn. The US Federal Reserve kept rates at near zero and made no changes to the pace of bond-buying, citing the economy’s ongoing recovery, with US stocks buoyed by the comments.

Fixed-income markets were fairly positive during the month, with the Investment Association UK Gilts sector returning an average of 2.8% in July.

The Organization of the Petroleum Exporting Countries (OPEC) reached a deal to increase oil production later this year, noting increased demand as economies continued to recover following successful vaccination programmes. This drove a sharp decline in the oil price around the middle of the month, although most of the decline subsequently reversed.

While equity markets were not so hot during July, the Earth certainly was recording the hottest month on record and a terrible start to the wildfire season in North America, Siberia, Africa and Southern Europe. There is so much to do in the climate change space and we continue to scour the landscape for investment opportunities that can help address these issues and generate positive returns for clients.

(All performance figures in sterling terms and rounded to one decimal point.)

Performance review

July was a mixed month for equities. While the developed markets of the UK, Europe and the US ended the month higher, it was a considerably poorer month for emerging markets and Asian equities. Meanwhile, fixed-income markets remained positive as yields fell and prices rose.

The Caerus Select Managed Portfolios made marginal gains at risk levels 3 and 4 thanks to the lower exposure to emerging markets and Asian holdings and a higher weighting to fixed-income assets, while risk levels 5 through to 10 posted a negative return for the month.

The developed market equity component of the portfolio lagged behind the global index. In spite of strong manager selection in Asia, with three of the holdings outperforming the regional index, absolute returns in this region were poor, losing an average of 6.5%.

Another area of weakness was the Quilter Investors Europe (ex UK) Equity Income Fund, managed by Schroders, which lost 1.9% in a positive market. It was held back by poor sector allocation most notably an overweight exposure to energy and an underweight allocation to information technology, sectors that underperformed and outperformed respectively.

The Allianz Continental Europe Fund was the strongest contributor, while the majority of our US equity holdings delivered positive returns

The Allianz Continental Europe Fund was the top performer with a return in excess of 5%. This was well ahead of its index driven by its overweight position to information technology and its stock picks within the industrials sector, in particular Kingspan.

Elsewhere, the majority of our US holdings produced positive returns with the Quilter Investors US Equity Growth Fund, managed by JP Morgan, the strongest in absolute terms, while the Schroder US Mid Cap Fund was among those that endured a poor month.

The emerging market equity component of the portfolio was ahead of the index, however, that masks some poor absolute numbers. While it was pleasing that three of the four holdings outperformed their index it was a torrid month for the asset class.

The Janus Henderson China Opportunities Fund fared the worst, losing around 11.9% as China cracked down on private education and technology stocks, which dented investor confidence and raised concerns that regulations could be extended to other sectors.

China’s poor performance also spilled over to the other holdings, although an underweight exposure to China in the Quilter Investors Emerging Markets Equity Income Fund (managed by Wells Fargo) meant that fund outperformed in the month.

The UK equity element of the portfolio was a bright spot in the month as it outperformed the index. Although the beginning of the month was weaker for UK stocks, as it was for many, around the spread of the Delta variant and its effect on global growth, the UK market bounced back thanks to a strong results season with growth holdings doing particularly well.

The BlackRock UK Equity Fund was the strongest performer as it gained nearly 3%. The Artemis UK Special Situations and Artemis Income funds also outperformed on the back of strong financial stock picks.

The BlackRock Gold and General Fund was the largest contributor to headline returns as it gained more than 4% as the price of gold rose in July.

In July, the alternatives basket of holdings made a modest loss. Gains by the PIMCO Dynamic Bond Fund were offset by losses from the Janus Henderson Absolute Return Bond Fund, the Allianz Fixed Income Macro and Jupiter Merian Global Equity Absolute Return funds.

Meanwhile, the fixed-income holdings were positive and ended the month ahead of the comparator. All our holdings made good ground as fixed- income markets advanced on the back of a slight change in investor sentiment as the Delta variant weighed on global growth concerns and investors sought some safety. Overall, government bonds outperformed corporate bonds with the iShares UK Gilts All Stocks Index Fund leading the pack with a return of 2.7%.

Outlook

As we move into the summer, we’re still grappling with the ongoing details of economic re-opening, improving employment trends, spiking inflation and the need to make a call on just how ‘transitory’ it might be. If inflation proves to be ‘stickier’ than the central banks predict, it could see interest-rate hikes being brought forward, which will impact markets and require us to adjust our positioning.

At the asset allocation level, we’re continuing to challenge our view on Europe. We chose to be underweight Europe in the second quarter of the year, which proved costly as the region outperformed. Our faith in emerging Asia also proved somewhat misplaced.

In both cases, however, we need to weigh up the future outlook and rate of change in economic growth and corporate earnings, rather than react to what we have missed so, while remaining alert to the risks, we’re likely to retain our positioning for now.

The first half of 2021 has been the second strongest start to a year for global equities since 1998. Since then, only the 15% gain registered in the first half of 2019 has beaten the progress made so far this year with global equities now up some 90% since their pandemic- induced nadir in March 2020.

All eyes will now be on the upcoming company earnings season, which could well show that the second quarter marked the peak in earnings growth as input costs continue to rise. Consequently, we expect to see bouts of heightened volatility so we intend to keep equity risk near the middle of our stated risk bands enabling us to cut more risk if markets begin to struggle.

Within fixed income, everything currently looks pretty fully valued, so while we have exposure to traditional fixed income for diversification purposes, we are not yet looking to take additional risk in this space and will continue to rely on our strategic bond managers due to the additional flexibility they have at their disposal.

With sharp spells of market volatility potentially lying ahead, alternative strategies offer an excellent way to reduce the impact of market directionality while generating consistent, lower-risk returns during what could be a period of significant upheaval for financial markets.

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Stuart Clark

Portfolio Manager

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