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Cirilium Active monthly commentary - August 2021

UK: Suitable for retail and professional clients.

Date: 20 September 2021

Market review

Rising coronavirus infections around the  world, notably in the US, did little to dent  investor risk appetite in August as global  equities continued their rally. Japanese  and US markets led the way as the MSCI  World Index generated a return of 3.6%.

The UK was one of the weaker major  markets during August but the FTSE  All-Share Index still delivered a total return of 2.7%, while the large cap FTSE  100 Index returned 2.1%.

Early in the month, the Bank of England  Monetary Policy Committee (MPC) voted  to continue its existing quantitative easing programme, although there were also hints  towards a slightly earlier first interest-rate  hike than previously indicated.

Purchasing Manager Index (PMI) survey  data in the UK continued to moderate but  remained strong for both manufacturing  and services sectors, suggesting that  while peak growth is likely behind us, the  outlook remains favourable.

Inflation also ticked lower as July’s  reading came in at 2% year-on-year, a  welcome decline from June’s reading of  2.5%. However, fears as to UK inflation  have not abated; although it expects it  to be temporary, the Bank of England  now predicts inflation to peak at 4% by  the year’s end.

The MSCI USA Index surged higher to  generate a 4% return over the period,  even as coronavirus cases rose.

Longer-term growth prospects were  also improved as the Senate passed the  bipartisan infrastructure package, which  includes $550bn of new spending over  the next eight years.

The portfolio delivered robust performance in August thanks to strong gains in global equity markets

Towards the end of the month, US  Federal Reserve (Fed) Chairman,  Jerome Powell, delivered his address at  the annual Jackson Hole symposium,  where he acknowledged the strong  employment gains recorded in recent  months but set this against the clear  downside risks posed by the Delta  variant of the coronavirus.

His comments suggested that the Fed’s  asset purchases will start to taper before  the end of the year, which was in line with  market expectations. Of more interest to  investors were his efforts to separate the  timing of the end of quantitative easing  (Fed asset purchases) from interest-rate  hikes; this suggests that near-zero rates  could be maintained for even longer.

As the vaccine roll-out continued apace  across the continent, European stocks  once again made gains as the MSCI  Europe ex UK Index returned 2.8%, just  outperforming the UK. Sterling weakness  over the month also helped boost  foreign equity returns.

The Chinese equity market was the  worst-performing of the major markets  over the month, up just 1%. Investor  sentiment in the region has been soured  by the regime’s on-going regulatory  crackdown to further its political agenda  and foster “common prosperity”.

Meanwhile, Chinese economic data  points towards slower growth as the  country continues to employ very  stringent lockdown measures at the first  signs of an outbreak. Services PMI data  in August suffered, dropping to 47.5  (below the reading of 50 which indicates  economic expansion).

China’s technology stocks also fell during  the month, following the publication of new rules in the country limiting the  amount of time children can play online  video games to three hours a week.

Despite having more than a 30%  weighting to China, the MSCI Emerging  Markets Index still posted a 3.7% return  for the month. Indian equities were  particularly strong performers amid  reports that India’s real GDP growth rate  hit a record 20.1% year-on-year in the  second quarter.

Government and investment-grade  bond returns were modestly negative  in sterling-hedged terms in August.

The Bloomberg Barclays Global  Aggregate Government - Treasuries  Index fell by 0.3% while the Bloomberg  Barclays Global Aggregate Corporate  Index declined a similar amount.

High-yield bonds, which tend to perform  better during rising equity markets,  delivered a positive return with the  sterling-hedged Bloomberg Barclays  Global High Yield Index up 0.8%.

Elsewhere, the oil price fell in August as  concerns over slowing demand from  China and the spread of the Delta variant  trumped the supply disruptions caused  by Hurricane Ida in the US.

(All performance figures in sterling terms and rounded to one decimal point, unless otherwise stated.)

*Currency hedging of foreign investments can help dampen currency fluctuations affecting the volatility of returns on your investment. Under most circumstances, in the Cirilium Portfolios we currency hedge foreign currency bond holdings except in cases where the foreign currency exposure is an explicit return-driver (eg emerging market local debt exposures).

Performance review

Global re-opening continued apace in  August, with a number of developed  markets further lifting restrictions,  despite a pick-up in coronavirus infection  rates. Economic growth was generally  strong, although it looks as though much  of the developed world has already  witnessed the strongest part of the  recovery, with August’s flash purchasing  managers’ indices (PMIs) moderating, yet  still at high levels.

On the virus front, it’s much ado about  vaccines. Specifically, the Delta variant  has continued to spread and daily cases  have picked up across the globe, but importantly, this has not led to a significant  rise in hospitalisations for countries that  have implemented a successful roll-out of  vaccination programmes, including the UK  and Europe.

Whereas in the US, hospitalisations have  increased more sharply, raising some  concerns that the link between infections  and hospitalisations has not been as  effectively broken there due to lower  vaccination take-up.

Against this backdrop, the Cirilium  portfolios delivered strong performance  for the month; a stark contrast to the  more moderate returns seen in July.

Equities did the heavy lifting as they have  done in the year to date, although listed  private equity also played its part for the  higher-risk portfolios.

We have long been a supporter of  listed private equity and it was great  to hear the manager of Pantheon say  that “none of our portfolio companies missed a beat during the pandemic” in a  recent meeting. Elsewhere, returns were  broadly flat across our alternative and  fixed-income managers.

There were some exceptional  performances across our equity  managers during the month, especially  the Montanaro stable of funds, which  benefited from the strong investor  demand for quality-growth companies.

The same demand helped to lift the  sustainable funds that were added  earlier in the year. Funds such as Jupiter  Global Sustainable, Premier Miton  European Sustainable Leaders and  Regnan Global Impact all performed  especially well in August.

Elsewhere, the strength of the domestic  re-opening in the UK helped the FTSE All-Share Index to gain 2.7% over the month,  but this return was far overshadowed by the  more domestically-focused FTSE 250 Index,  which delivered a particularly robust 5.3%.

This was reflected in the strong  performance of the Mercantile Trust and  the Premier Miton UK Value Opportunities  and Polar Capital UK Value Opportunities  funds, all of which (selectively) fish in those waters. It was a similar story in  Europe with small and medium-sized  (SMID) businesses leading the charge.  This resulted in strong performance for  the Montanaro European Income and the  Premier Miton European Opportunities  funds, among others.

It’s also pleasing to report a stronger  period for our Japan managers.

We remain optimistic that there is more  to come and it is encouraging to see  some analysts start to share our view,  including the Bank of America which now  has a ‘buy’ rating on Japan.

If there was an area of the portfolios that  we would have expected more from, it would be the US. Interestingly, while  SMID cap outperformed large cap in  Europe and the UK, it underperformed  in the US. Consequently, our wider  focus across US businesses translated  into returns that lagged the broader  index but, according to our underlying  managers, their portfolio companies are  outperforming operational targets and  we are already starting to see stronger  performance in September.

General portfolio maintenance aside,  the main investment activities of the  month were tactical and opportunistic  strategies.

Tactical meant trimming positions that  have performed well. This included the  HarbourVest Private Equity, the Polar  Capital Automation & AI and the Sands  Global Leaders funds. We also reduced  credit by trimming our holding in Hermes  Unconstrained Credit, for example.

It should be noted that there has been  no change to our conviction in these  managers and we would happily buy  back on weakness.

Opportunistic moves included adding to  our Asia and emerging market managers  following weakness in the same spirit as highlighted last month. This included  adding to the Fidelity China Consumer,  the Pacific North of South Emerging  Markets Equity and the Wells Fargo  Emerging Market Equity Income funds.

These purchases were financed with the  proceeds from the reductions listed above.

Leading performers included the Montanaro stable of funds and our sustainable funds

Outlook

Economic data releases in August  highlighted the inevitable, in our opinion;  namely, that the global re-opening (and recovery) has continued, but that  countries first out of the blocks are now  seeing the pace of their recoveries start  to slow.

This may, to some degree, reflect supply  bottlenecks following the disruption  caused by the pandemic shutdown, but  it may also suggest that consumers have  bought all of what they need and are no longer prepared to chase prices higher for  cars, houses and appliances, for example.

Recent inflation data has been topping  Wall Street estimates, raising the narrative  of monetary tightening. However, data  continue to be mired by post-March 2020 after-effects. Although they should  not be extrapolated into the basis of a new regime, they may be here for a  few quarters longer than previously anticipated.

More important will be the handoff  from government transfer payments to  the private sector re-booting, for two  key reasons. First, employment, for the  likely speed of monetary policy change,  and second, wages, which will help us to  understand the influence on corporate  margin pressures and the continued  ability of consumers to absorb, thus far,  one-off price shocks.

While the Delta variant continues to pose  a risk to the global outlook, for developed  economies this is likely to be in the form  of supply disruptions and/or mobility  restrictions. In response, we have already  seen a number of countries announce  booster programmes to deliver third  doses to those most at risk.

For financial markets, August’s data  releases in September may simply provide  confirmation that the easiest part of the  recovery is behind us as we suggested last month. That does not mean there  is no upside for risk assets – we still expect economic and corporate earnings  growth, but investors will need to be more  selective moving forward, have a little  more patience and acknowledge there  may be a few bumps along the way.

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Paul Craig

Portfolio Manager

Hinesh Patel

Portfolio Manager