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Cirilium Blend Commentary - August 2021

UK: Suitable for retail and professional clients.

Date: 22 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 performing 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.

The portfolios delivered positive returns in August, helped by manager selection in the UK.

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.

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 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 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 debt exposures).

Performance review

The Cirilium Blend Portfolios delivered positive returns during August, ranging from 0.4% for the lowest risk profile – Cirilium Conservative Blend – up to 2.3% for the highest risk profile, Cirilium Adventurous Blend.

This compares to a background of mildly negative fixed-income markets and strong returns for global equities once translated back into sterling. UK equities underperformed global equities, while US technology companies were the best performers of the month.

From an asset allocation perspective, we slightly increased the portfolios’ equity allocations during August, adding around 2% to the Cirilium Conservative and Balanced Blend portfolios, 1.5% in Moderate Blend and 1% in Dynamic Blend.

We added the Quilter Investors Global Equity Value Fund and the JO Hambro UK Dynamic Fund to the portfolios.

This action was taken with the aim of maintaining sufficient investment exposure to rising markets, to offset some of the portfolios’ other tactical tilts that deliver a ‘risk-off’ bias. We are now broadly neutral in terms of our current equity allocation, when compared to our strategic asset allocation model, alongside an overweight exposure to higher-yielding corporate and emerging market bonds.

Within equities we maintain a small underweight position towards Europe and an overweight towards global healthcare. We remain underweight towards high-quality bonds and therefore less sensitive to changes in interest rates. Within the fixed-income universe we have an overweight position in US Treasuries as well as positions in high-yield and emerging market local currency bonds.

The two standout equity performers in the portfolios during August were both UK-focused. The Montanaro UK Income Fund added around 6% in sterling terms, while the Miton UK Value Opportunities Fund gained more than 5% over the month.

Both managers benefited from the continued strong performance of UK small and mid-sized companies, combined with higher growth companies becoming more sought after against a backdrop of rising Delta infections and concerns over whether the pace of post-pandemic recovery will be sustained.

Meanwhile, the worst performer over the month was once again the Fidelity China Consumer Fund, although the much smaller loss of 1.4% in August suggests that the Chinese market has started to consolidate following the increased quantity and severity of government regulations against large companies. Valuations are looking more attractive at these levels, although we continue to expect some volatility in the near term.

Our best performing fixed-income holding was the 1167 Global High Income Bond Fund, which focuses on emerging market bonds issued in their own currency. This fund rallied despite the increasing Delta variant infections in Asia, albeit in a supportive environment for economically-sensitive assets.

In the alternatives space, the Mygale Event Driven Fund was the best performing strategy, rallying more than 1% on the month to bring its return to around 4% on the year. This manager looks to take advantage of specific corporate events (such as mergers or takeovers) to deliver low-risk returns and the current environment with high volumes of takeover activity is proving supportive.

During the month, our portfolio activity included the introduction of two new equity managers and the removal of an existing holding.

Within the UK we switched from the Quilter Investors UK Large Cap Equity Income Fund (managed by Artemis) into the JO Hambro UK Dynamic Fund. Our rationale was to capture the more company-specific outperformance from JO Hambro, which focuses on companies that are undergoing strategic change.

In particular, the valuations in the UK market are proving attractive for corporate takeovers, which has benefited this fund so far this year due to its process of searching for hidden value within companies.

We also added the Quilter Investors Global Equity Value Fund (run by RWC) to increase the Blend Portfolios’ overall exposure to value-orientated strategies. In this fund, the manager’s focus on income leads to a portfolio of companies with strong cash generation but low valuations, which should offer opportunities for growth through revaluation but also provide defensive benefits if the overall investment environment worsens.

Outlook

As we enter the autumn months, equity market valuations have remained stretched, with positive returns being driven by strong earnings over the summer. The tone of corporate updates has worsened, however, with mentions of inflation, supply-chain bottlenecks and ‘difficulties filling job vacancies’ markedly increasing compared to previous quarters.

At the same time, the macroeconomic environment is cooling somewhat. Government furlough schemes are beginning to expire and central banks are starting to position for a reduction in their ongoing ‘extraordinary’ measures to support liquidity and broad financial market health.

Together this has resulted in a decline in investor sentiment – the extreme bullishness of earlier this year has receded somewhat into a more cautious optimism. Perversely, we would view this as a positive development – after all, if everyone is as bullish as possible, where will the next buyer emerge from in order to drive the market higher?

The Mygale Event Driven Fund performed well in the alternatives space, helped by increased M&A activity.

For equities, it feels like the path of least resistance is a grind higher from current levels, supported by strong earnings growth as western economies complete their post-pandemic re-opening. However, we would expect future returns to be somewhat muted given the current high valuations.

In terms of potential risks, it strikes us that those high valuations mean markets have less room to weather disappointments – while not quite priced for perfection, markets seem to be anticipating an ongoing stream of good news.

We are reflecting this in the portfolios by retaining at least a neutral allocation to equity markets – now does not feel like the time to turn fully defensive. However, we are increasingly focusing on the ‘what if...?’ analysis and exploring ways to build in ballast to the portfolios in case markets stumble over the coming months. We also have sufficient cash allocations to enable us to put capital to work if markets offer us the opportunity to buy at more attractive levels.

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Ian Jensen-Humphreys

Portfolio Manager

Sacha Chorley

Portfolio Manager

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