Fears of inflation and the shifting stance of central banks weighed down global stock markets in May, resulting in relatively modest returns in European markets and losses in the US equity market over the month. Returns were reduced by the relative weakness of the euro and the US dollar to sterling which, in the case of the US, translated local currency gains into losses for sterling-based investors. As a result, the MSCI World Index ended the month down 1.1%.
However, the global vaccine roll-out programme and the associated reduction of both new infections and fatalities allowed some developed economies to re-open. In the UK, mid-May saw pubs, restaurants and non-essential retailers opening their doors, providing a much- needed boost to the economy.
In Europe, where the vaccination programme has stepped up a gear after a slow start, there was a similar uptick in business activity. During the period, the FTSE All-Share Index returned 1.1%, while the MSCI Europe Ex UK Index delivered 1.6%.
In the US, higher-than-expected inflation fuelled by pent-up consumer demand and supply restraints, stoked concerns that the US Federal Reserve would be forced to increase interest rates sooner rather than later.
Meanwhile, a strong rise in the pound versus the US dollar and Japanese yen overwhelmed local currency returns when translated back into sterling. This meant the MSCI USA Index recorded a loss of 2.1% in sterling terms, despite delivering a modest positive return in US dollar terms.
Despite the weakness of the US dollar, which generally provides a strong tailwind for emerging markets, the MSCI Emerging Markets Index retreated marginally in May, falling 0.3% over the month.
China was particularly hard hit, with the MSCI China Index falling 1.8%. This was, in the main, driven by slow growth in its factory sector caused by the increasing cost of materials and pandemic-induced strains on the country’s relations with its overseas partners.
The bond market showed some signs of life towards the end of the period as positive employment figures from some developed economies helped push bond yields higher (and prices lower). The 10-year US Treasury bond yield edged up in the final few days of May, reaching its highest level since mid- April, as the US posted better-than-expected unemployment figures. Over the month, however, there was little noticeable change.
Elsewhere, the Bank of England confirmed that while its existing programme of £150bn of UK government bond purchases remained unchanged, the pace of these purchases would now be slowed somewhat. However, it stressed that the change was an operational decision rather than a change in the stance of monetary policy, noting that it will continue to monitor the situation and “take whatever action is necessary to achieve its remit”. Against this backdrop, UK gilts delivered modest gains during the month.
In hedged sterling terms*, returns from government, investment-grade and high-yield bonds were relatively flat during the period, with the Bloomberg Barclays Global Aggregate Government - Treasuries Index up 0.2%, the Bloomberg Barclays Global Aggregate Corporate Index adding 0.5% and the Bloomberg Barclays Global High Yield Index up 0.6%.
(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).
Against this backdrop, the performance of the Cirilium Portfolios was fairly flat over the month. Diversification across asset classes, investment styles and geographical regions broadly resulted in returns offsetting each other. For example, growth-orientated holdings offset our more value-focused managers, while a stronger pound offset returns from overseas investments.
Equities provided the greatest contribution to returns during the month. Regionally it was managers within the UK and Europe that delivered the strongest returns and contributed most to performance.
In the UK, the JO Hambro UK Dynamic and Premier Miton UK Value Opportunities funds were the notable winners, as their respective portfolios benefited from increasing confidence in a wider reopening of the UK economy together with a focus on quality businesses.
In Europe, the Montanaro European Income Fund and the SPDR S&P European Dividend Aristocrats exchange-traded fund (ETF) provided the strongest returns and contribution for similar reasons as for the UK. In addition, there was less of a currency translation offset than for the US.
In the US, Berkshire Hathaway gained over the month even in sterling terms, but this was more than offset by the weaker performance of previously strong performers in the portfolios, such as the Granahan US SMID Select, Premier Miton US Smaller Companies and Polar Capital Automation and AI funds.
However, we should remember the benefits of diversification and these extremely well-managed funds have provided a lot of the ‘heavy lifting’ over the past year and continue to offer exciting prospects for the future.
Elsewhere, equity returns were disappointing in Japan and muted in Asia and emerging markets, but this was largely as a result of currency translation effects.
Within alternatives, it was another positive month for our listed private equity managers, including HarbourVest, Pantheon International and Riverstone Energy.
Meanwhile, the returns from our fixed-income holdings were far more muted over the month, although the Wellington Opportunistic Fixed Income Fund and the Wellington Emerging Market Local Debt Advanced Beta Fund both performed well.
Our investment activity in May followed the same theme as the previous month, in terms of adding to our ‘quality’ value exposures and reducing risk across the board, albeit to a lesser degree.
However, during the month we also introduced three new portfolio holdings: the Jupiter Global Sustainable Equities Fund; the Regnan Global Equity Impact Solutions Fund; and the Premier Miton European Sustainable Leaders Fund.
The recent pull back in ‘growth’ style investing has presented a timely opportunity for us to increase exposure to this secular theme, at a time when the political momentum in this area has never been stronger ahead of the UN Climate Change Conference (COP26) to be held in the UK in November.
While all these funds are new to the portfolios, two of the managers are well known to Cirilium. The manager of Regnan is Tim Crockford, who used to manage the Federated Hermes Europe ex UK Equity Fund, which was previously held across the portfolios.
Meanwhile, Carlos Moreno and Thomas Brown, who manage the Premier Miton European Sustainable Leaders Fund, also manage the Premier Miton European Opportunities Fund, which has proved very successful for Cirilium over the years.
Abbie Llewellyn-Waters, the manager of the Jupiter Global Sustainable Equities Fund, is the new kid on the block for Cirilium. However, we were attracted to the strength of her process, quality of management, the diversification benefits to the Cirilium portfolios and the strong secular theme of the portfolio.
Economic growth may begin to slow from the current frenetic pace but the outlook for the second half of the year still looks bright, especially for those countries that are further along in their vaccine roll-outs. As more countries step-up efforts to vaccinate their populations, the economic recovery should continue to broaden out.
However, the key question may not be whether growth is strong, but rather how strong it will be. This raises concerns for investors regarding how central banks will react to potential further upside surprises on economic growth.
We have seen how monetary authorities have been able to orchestrate an economic recovery following the financial crisis and the pandemic, but how will they tackle a boom? Investors appear increasingly worried that if inflation does prove persistent rather than transitory (which is the current thinking of the US Federal Reserve), then central banks might have to raise interest rates quickly to slow down an economy that is running too hot. A small taste of this concern is what created some of May’s market volatility.
We are not yet expecting either growth or inflation to maintain these heady levels for an extended period of time. Consequently, we believe equities should continue to provide an attractive investment in an environment of modestly rising inflation. But investors will need to be selective, as not all companies will be able to pass on higher input prices to consumers and/or offset rising costs with rising sales.
Diversification across regions, market capitalisations and styles should provide a solid foundation to benefit from the cyclical upswing while retaining exposure to longer-term secular themes.
In summary, equities have had a strong start to the year and while we wouldn’t be surprised to see a few wobbles along the way, we believe the outlook for the economy, equity markets and equity-related strategies remains positive. We are also starting to become a little more sanguine on fixed-income markets following the pull-back in the first quarter of the year, although inflation-linked bonds currently look a bit expensive.