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Cirilium monthly - May 2020

Suitable for retail clients.

Date: 17 June 2020

In this month's edition:

 

Market review

Lockdown restrictions began to be eased around the world in May, albeit tentatively as countries tried to avoid risking a ‘second wave’ of coronavirus.

Official figures released in May showed that the UK economy shrunk by 2% in the first quarter of 2020, the largest quarterly fall since 2008, as the lockdown restrictions impacted economic growth. But the FTSE All Share index shook off any concerns about a looming recession to gain ground in May, delivering a return of 3.4%. The UK sold government bonds with a negative yield for the first time in May, while Bank of England governor Andrew Bailey said he would not rule out negative interest rates. The ICE BofA 1-10 Year UK Gilt index was up just 0.4% by the end of the month.

Earlier in May, the third round of talks between the UK and European Union (EU) started up in a bid to decide on their future trading relationship, although an exchange of public letters between the chief negotiators appeared to show a frosty relationship. Meanwhile, towards the end of the month the European Commission unveiled plans for a €750bn coronavirus recovery package, made up of loans and grants that would be available to all 27 EU members. While France and Germany have backed the plans, it will require consent from all member states, with some countries appearing reluctant to provide ‘handouts’ to more indebted countries.

Elsewhere, the Italian government approved a second coronavirus support package in May, worth €55bn, while the German Federal Statistical Office’s initial flash estimate for first quarter GDP growth showed that the German economy contracted by 2.2% quarter-on-quarter. This is the biggest quarterly drop for the eurozone’s largest economy since the global financial crisis. But despite the poor economic data coming out of Europe, the MSCI Europe ex UK index generated a 7.8% return during the month, as monetary and fiscal stimulus continued to buoy markets.

In the US, deaths from coronavirus topped 100,000 as President Donald Trump’s handling of the crisis came under scrutiny. The publication of non-farm payroll data showed that more than 20 million people in the US lost their jobs in April. However, markets continued to take a more optimistic view, with the MSCI USA index ended the month 7.3% higher. During May the US also held its first sale of a 20-year bond since 1986, prompting a fall in US 10-year and 30-year Treasury bond yields. The ICE BofA US High Yield index ended the month up 6.7%, compared to the ICE BofA US Treasury index, with total returns of just 1.7%.

Towards the end of the month, demonstrations calling for an end to police violence and anti-racism protests broke out across the US, after footage emerged of the death of African American George Floyd at the hands of a white policeman in Minneapolis, placing President Trump under further scrutiny over his handling of the situation. Markets were resilient in the face of the protests, but it is something to be aware of given the recent experience of the Hong Kong demonstrations.

Trade tensions between the US and China also flared up in May as President Trump threatened to hit China with new tariffs. The US President has continued to blame China for the coronavirus outbreak and announced the US would be withdrawing from the World Health Organisation (WHO), which he claims is too biased towards China.

Meanwhile, China held its annual meeting of parliament, in which it announced it would abandon its GDP growth target, citing the uncertainty caused by the global pandemic. During the meeting, the National People’s Congress also announced further fiscal stimulus and offered more support for small and medium companies. But the decision to impose national security laws on Hong Kong prompted protests to restart in the region and some international outcry. This meant that despite having been one of the first countries to exit lockdown, by the end of the month the MSCI China index gained just 1.5%.

Emerging market equities continued their upward trajectory in May, with the MSCI Emerging Markets index returning a positive 2.8% during the month. Although the individual countries’ handling of coronavirus began to diverge with, for example, lockdown restrictions easing in India towards the end of the month, even as the number of coronavirus cases spiked.

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

 

Performance review

It was a good month for the Cirilium portfolios, although we wholeheartedly recognise that there is still much lost ground to recover.

Equities provided the largest contribution to monthly returns for all but the Conservative Portfolio, where fixed income holdings were the dominant contributor. This partly reflects the sizeable allocation to fixed income, but also highlights a strong outcome from across many of our underlying fixed income managers and exposures.

For example, emerging market debt and corporate credit were among the biggest positive contributors to performance, while Pollen Street Secured Lending was one of the outright strongest performers following a sharp contraction in the discount to net asset value (NAV) - where the share price is trading below the value of the underlying investments - although there still remains room for further improvements in the discount to NAV.

Within equites, our exposure to Japan and Europe proved to be significant contributors. For Japan, we benefited from strong market returns, a fall in the value of the pound and being overweight the region relative to our peers. One of our strongest performers was the Baillie Gifford Japanese Income Growth Fund. For Europe, we also benefited from positive market returns and a fall in the pound, but also from exceptionally strong performance from our underlying managers. For example, both the Miton European Opportunities and Montanaro European Mid-Cap Funds returned more than 10% for the month.

This also highlights the strong performance of small and mid-cap companies in May, although returns were somewhat muted in the UK possibly as a result of renewed Brexit fears. For example, the Granahan SMID Select, Miton US Smaller and Montanaro Better World Funds all achieved gains in excess of 10%. In addition, the Montanaro European Income Fund gained around 9% while the Montanaro UK Income Fund gained little more than 3%, although the former would have benefited from the fall in the value of the pound.

Within alternatives, hedge funds were little changed over the month, while real assets such as infrastructure were modestly higher and listed private equity funds generally performed well.

Investment activity was largely driven by general portfolio maintenance. However, there were opportunities to make a few changes. For example, we used the partial recovery in the performance of the Invesco European Fund as a good opportunity to reduce this holding in favour of Berkshire Hathaway, Warren Buffet’s US-centric investment vehicle. This fund offers a slice of America at a discount to the sum of its constituent parts, providing a rare opportunity to access this well-known investment house at an attractive price.

We also reduced the Wells Fargo Emerging Income Fund in favour of the Blackrock Emerging Markets Equity Tracker Fund. We retain our confidence in Wells as a management team, however, the focus on income may prove restrictive in an environment where companies are looking to preserve cashflow or reinvest into their businesses. Elsewhere, we made a small reduction in the Polar Capital UK Value Opportunities Fund in favour of the Polar Capital Automation & AI Fund, where we feel the secular trends of the latter should be even stronger following the coronavirus pandemic.

Within fixed income, we reduced our absolute return focused funds in favour of those with greater upside potential, including Fair Oaks Income and Pollen Street Secured Lending.

 

Outlook

The sheer speed and size of the monetary and fiscal stimulus, together with successful vaccine trials and a gradual reopening of economies is providing a strong positive tonic for investors despite risks that are associated with the coronavirus, along with many of the world’s other woes. It would be easy to say that we are cautiously optimistic, but that would not really say much of what we are thinking or doing. Practically, we remain positive on equities, but we still have a modest equity hedge in place for the moment. We retain confidence in our managers, but we are making changes across the portfolio. We favour diversification, but we are slimming down the portfolio. In essence, we are seeking to recover lost performance from the market falls in March, while navigating unchartered waters as economies reopen by rebalancing the portfolios to reflect life after lockdown.

Economic activity over the past month suggests the second quarter will be worse than the first but investors are looking ahead to a possible recovery. However, significant uncertainty remains over when economies can fully and sustainably reopen and how quickly they will rebound. The longer infection rates remain high and social distancing is required, the more likely there will be more lasting impacts on the economy. Central banks and governments have so far helped cushion the blow to the global economy and markets, but success will be measured by the extent to which companies avoid solvency problems and workers return to employment. Unfortunately, for some businesses there is likely to have been permanent damage caused by the government lockdown.

Paul Craig

Portfolio Manager

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