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Cirilium Active monthly commentary - July 2021

UK: Suitable for retail and professional clients.

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 as the MSCI World Index returned 1.2% over the period. 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. The FTSE All Share Index finished the month up 0.5%, while the FTSE 100 Index managed only a 0.1% return as small cap stocks outperformed large caps in the UK.

Global and European managers were the strongest contributors to equity returns

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 MSCI China Index lost 14.4%, while the MSCI Emerging Markets Index fell 7.3%.

Europe’s vaccine roll-out overtook America’s efforts during the month, but  European equities failed to outperform US stocks. The MSCI Europe ex UK Index rose 1.5%, slightly behind the MSCI USA Index’s 1.7% gain. 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.

In hedged sterling terms*, returns from government and corporate bonds were positive during the month, with the Bloomberg Barclays Global Aggregate  Government - Treasuries Index up 1.4% and the Bloomberg Barclays Global Aggregate Corporate Index gaining 1.3%. However, high-yield bonds remained fairly flat, with the Bloomberg Barclays Global High Yield Index up 0.1%.

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.

(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

Against this backdrop, the Cirilium  Portfolios were little changed on the month  with the lower-risk portfolios marginally  higher, while the higher-risk portfolios were  marginally lower. Diversification across  managers, asset classes, investment styles  and geographical regions helped mitigate  some of the volatility during the month but  also resulted in lower overall returns.

Disappointingly, for the higher-risk  portfolios, the weak performance of  Asia/emerging market equities and the  Granahan US SMID Select Fund more  than offset the strong performance  from European equities and our global  managers, but it did allow us to add to  previously reduced positions at lower prices.

That said, there were some exceptional  performances among our equity  managers during the month including  the Premier Miton European  Opportunities Fund and all of the  Montanaro stable of funds (European  Income, UK Income, European Mid Cap  and Better World), to name but a few.

Lower-risk portfolios benefited most from fixed-income and alternative exposures

Within the Montanaro funds the  managers focus on quality small and  medium sized companies that can  deliver growth with a profitability focus  and, for income funds specifically,  maintain a discipline of paying  consistent and stable dividends. In all  cases the portfolios benefited from a  tailwind for smaller companies in the  UK and Europe during the month, as  well as ‘growth’ stocks being in favour  compared to ‘value’ stocks in the US.

But even these champions were unable  to offset weakness in Asia, emerging  markets and Japan. Our exposure to  Asia and emerging equity markets had  previously been trimmed into rising  prices, but the sharp pull-back in July  weighed on investment returns for the  month. The biggest casualty was the  Fidelity China Consumer Fund, which is  held in the Cirilium Moderate, Dynamic  and Adventurous portfolios.

Our longer-term outlook for Chinese  and Asian equities remains positive, but  sentiment is likely to remain fragile in the near-term until the length and breadth of  a regulatory clampdown becomes clearer.

That said, we did take the opportunity  to rebalance a selection of our Asia and  emerging market equity managers.

Elsewhere, while the S&P 500 Index  in the US reached a new high this was very much isolated to larger companies.  US small and mid-sized companies  generally ended the month lower, which  resulted in a disappointing month for  the Granahan US SMID Select Fund,  which was down, but certainly not out as  their portfolio companies continued to  deliver robust earnings.

Consequently, equities were not the  largest contributor to returns in July, but  for some portfolios they were the largest  detractor of returns. For the lower-risk  portfolios, alternatives, such as our  exposure to property, and fixed income  provided the strongest contribution to  returns. It was also encouraging to see  further strong gains from our private  equity exposure in the form of our  holdings in Harbourvest Global Private  Equity and Riverstone Energy.

In terms of investment activity, aside  from general portfolio maintenance, the  main actions in the month were utilising  tactical and opportunistic strategies.

In terms of tactical changes, this meant  putting cash to work for the lower-risk portfolios. This does not reflect  a sudden change in view for bond markets, rather the acknowledgement  that we may need to wait longer for a better entry point. Therefore, we  invested across a broad range of funds  and managers that should be able to  provide a better return than simply  holding cash.

This included adding the Fair Oaks Dynamic  Credit Fund to the Cirilium Conservative  and Balanced portfolios, and the Janus  Henderson Asset Backed Securities Fund  and the Wellington Global Total Return  Fund to the Cirilium Conservative, Balanced  and Moderate portfolios.

Meanwhile, opportunistic changes  involved adding to our Asia and  emerging market managers following  a sharp pull-back. Furthermore, for  the higher-risk funds we increased our  weighting to the region by around 1%  by adding to the Wells Fargo EM Equity  Income Fund, including a new holding  for the Cirilium Dynamic Portfolio.

These purchases were financed by  trimming holdings that had performed  well including Harbourvest Global  Private Equity, the Polar Capital  Automation & AI Fund, various  Montanaro funds and the Sands Global  Leaders Fund.

Outlook

Within financial markets, equities and  bonds painted contrasting pictures in  July with the S&P 500 Index, for example,  hitting new all-time highs while US  Treasury yields fell to lows last seen in February.

Such a sharp decline in yields would  normally imply a significant downgrade  to the growth outlook, but there appears  to be a range of factors behind the move  lower including purchases by the Federal  Reserve, institutional investors looking to rebalance following a strong period  for equities and elevated cash balances  across the private sector. In other words,  technical factors rather than fear factors.

The most eye-catching moves during  the month were within emerging  markets, with turmoil in Chinese stock  markets particularly notable. Reforms  to the private tutoring sector triggered  extreme volatility towards the end of the month, with the changes coming  hot on the heels of increased scrutiny  being applied to the technology sector,  as well as actions taken to influence the  housing market.

The changes, while arguably a little  harsh, appear to reflect the renewed  focus from policymakers on their long-term structural goals, with efforts  to curb inequality and ensure healthy  competition across all sectors.

With equity markets having already  delivered strong returns in the first half  of the year, many investors appeared  to focus on the downside risks in July.  The Delta variant could certainly lead  to a slower rebound in parts of the  world where vaccination rates are  lower. Furthermore, consumers may  be hesitant to adopt a full return to  normality while the risks of infection  remain high.

That said, there is little evidence at this  stage to suggest that the economic  recovery will be derailed. Consumers  continue to power the rebound in  growth while policymakers continue to  provide ample support, probably more  than is currently needed.

In summary, the ‘best’ of the recovery  may now be behind us, both for the  stock market and many parts of the  global economy, but ultimately, we still  believe there is scope for risk assets to  move higher over the remainder of the  year, albeit with a bumpier ride.

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Paul Craig

Portfolio Manager

Hinesh Patel

Portfolio Manager