multi-sector portfolio positioning

Multi-SectorPortfolio Positioning

October 2021

Overview Slides 1. Summary

2. Global Macro Environment & Markets

3. Economic scenarios (Bear / Base / Bull Case)

4. SAA vs TAA Positioning

5. Investment Positioning per Asset Class

6. Outlook

• No changes to tactical asset allocations.

• Tilts across all risk profiles excluding Conservative (Neutral) remain Growth -2% and Defensive + 2%

• Within growth assets, we are gradually taking a more “defensive” posture via fund and security selection.

• Economic conditions continue to improve but at varying paces depending on region, country and sector.

• Fiscal stimulus will roll off as economies open-up.

• Inflation is expected to remain elevated in the short term before moderating. Risks to the upside.

• Major developed market central banks continue to retain supportive monetary policies although the peak of QE is behind us.

• All asset classes remain expensive, however with earnings growth, positive economic data and supportive monetary policy, growth assets remain attractive relative to defensives.

• Return expectations should be realistic and volatility expected.

• Market environment remains uncertain as a variety of issues have the capacity to impact sentiment over the short term.

Global Economy Markets Portfolio Positioning

Summary

MULTI-SECTOR PORTFOLIO POSITIONING

Q3 review

MULTI-SECTOR PORTFOLIO POSITIONINGSource: VanEck Viewpoint October 2021

• Most asset classes delivered positive performance, but volatility increased through September.

• Growth assets did the heavy lifting, particularly International equities, however EM's struggled due to the large China weighting in the Index.

• Fixed Income indices were broadly flat as bond yields rose.

• Economic data continues to improved particularly in the DM's - PMIs, GDP, business and consumer sentiment.

• Emergency fiscal programs begin to expire (US, UK and Aus) while peak QE is behind us.

• Elevated inflation, global supply chain issues, and slowing company earnings growth into 2022 are issues facing investors

Asset Class returns for Q3

Monetary Policy

• The recent US Fed meeting offered the market hints on the wind down of their asset purchase program (market currently expects November) and the ECB slowing the pace of net asset purchases.

• The key theme across the DM world is that peak QE is behind us, but we expect rates to remain low (they may rise but still be low) for the medium term.

• However, each country/region face different recovery paths likely leading to diverging monetary policy outcomes. Central banks in South Korea, Hungary and Norway have already moved official interest rates.

Peak QE is behind us

Global macro-economic environment


Source: J.P. Morgan Guide to the Market Australia 4Q 2021

Fiscal stimulus will roll off as economies open up




Fiscal Policy

• Emergency Fiscal programs have started to roll off in September; “JobKeeper 2.0”, the UK Furlough scheme and the US temporary federal unemployment benefit supplement.

• As economies re-open, businesses and employees now have less government support. The next 6 months will provide a clearer picture on whether business led growth eventuates, a requirement for a sustainable recovery.

• Consumer finances would undoubtedly have been in worse shape had governments not taken decisive fiscal action in 2020.

• Specifically in Australia, “consumer euphoria” may benefit services (entertainment, travel and hospitality) as lockdowns ease.

Source: UBS, The Compendium, Sep 2021

GDP

• As credit growth in China has slowed, so too has economic growth. Targeted regulations in property and education are currently headwinds for these sectors. Government intervention is designed to benefit the broader economy, with a rebalancing of the growth model in the long run away from exports towards domestic spending.

• The US recovery is more advanced than other DM economies and likely to retain above-trend growth into 2022.

• Europe has more catch-up potential (to regain pre-Covid GDP levels), certainly more than the US, as economies open-up given high vaccination rates. It is also expected to receive more fiscal support in 2022.

Varying pace of economic recovery




PMIs

• Traditional economic data such as Purchasing Manager’s Index GDP growth rates paint an improving picture.

• Noticeable weakness in Emerging Markets, particularly China, Mexico and Russia, as Delta outbreaks have curbed business activity and social mobility.

• The bounce back in activity in DM regions (US, UK & Eurozone) has been significant as economies re-open. The pent-up demand will likely be temporary as evidence suggests that peak growth is behind us.

Varying pace of economic recovery




Inflation

• Inflation remains elevated in DM's, particularly the US. Much of the increase reflects a rebound in demand for services from previously depressed levels.

• Major central banks are still voicing confidence that the drivers are largely “transitory”. While this thesis is still supported by the impact of base effects, inflation outcomes have remained elevated for longer than expected.

• Logistic challenges including elevated freight costs and supply-side bottlenecks suggest the risks are to the upside.

• Investors need to be mindful of the potential impact on all asset classes of a monetary policy mistake if inflation is not transitory.

CPI inflation expected to remain elevated before moderating


Source: Janus Henderson, Aus Economic View, Aug 2021


Earnings Growth and Valuations

• Equities have all witnessed impressive earnings growth in 2021, recovering 2020 declines.

• Future earnings growth is expected to moderate, and, depending on region, sector or industry, vary substantially.

• Valuations are elevated. Given the uncertainty of outcomes, active management is warranted to position portfolios in pockets of value and adjust portfolios as changing conditions dictate.

Earnings growth supports growth assets

Equity Markets



Bear Case Base Case Bull Case

30% 60% 10%

• Economic growth is impacted by longer than expected setbacks; new variants, vaccine efficacy, distribution issues.

• Withdrawal of Fiscal stimulus is not replaced by business led growth.

• Unexpected sustained rise in inflation leading to earlier than flagged withdrawal of monetary stimulus.

• Elevated risk to valuation of growth and defensive assets and increasing correlations particularly during sustained levels of structural inflation.

• Increased geopolitical tensions and/or conflicts.

• All assets are expensive relative to historical values with short-term investment outcomes remaining uncertain.

• Relative to defensive assets, valuation of growth assets continues to be attractive.

• Economic conditions continue to improve but at varying paces depending on region, country and sector.

• Fiscal stimulus will roll off as economies open-up.

• In the short term, inflation is expected to remain elevated before moderating.

• Major Developed Markets' central banks continue to retain supportive monetary policies although peak QE is behind us.

• Geopolitical tensions remain a concern with risk on the downside.

• Global economic conditions and environments improve quicker than expected.

• Synchronized corporate capex boom and the consumer relief euphoria.

• Inflation and/or expectations for sustained inflation growth increase however remains below Central Banks targets.

• Growth asset prices improve in line with economic growth and corporate earnings.

• Geopolitical tensions ease

Economic scenarios (6 months)

SAA vs TAA Positioning


Asset Allocation Changes

• Despite elevated valuations, the economic recovery supports growth assets via expected earnings growth.

• Expected returns in defensive assets remain low and on balance we have retained the existing asset allocation this quarter.

• However, within growth assets, we believe it prudent to gradually take a more “defensive” posture via fund and security selection.

• Our short duration stance within fixed income provides much needed capital perseveration in a rising rate environment. This position has proven useful when actively rebalancing portfolios.

• Cash provides liquidity should the market provide attractive opportunities.

Source: Elston Asset Management

International Equities Allocations


• We have reduced the core passive exposure via the Vanguard MSCI World ETF.

• The US mega-caps, which dominate the index, offer compelling growth opportunities, but increasing regulatory scrutiny, minimum global tax rates plus excessive valuation of the 10 largest companies relative to the rest of the index are significant headwinds.

• We believe it makes sense to add more to an active manager that can position for these risks and adjust to changing market conditions. We have increased exposure to GQG Partners as we see them being capable of positioning their portfolio according to changing market environments.

Core 50%

Satellite 50%

GQG Partners Global Equity Fund

(Weight: 20%)

UBS Emerging Markets Fund

(Weight: 17.5%)

Franklin Global Growth Fund(Weight: 12.5%)

The recent annual reporting season delivered robust earnings growth with dividends the key bright spot.

Unsurprisingly given ongoing uncertainty related to COVID-19 disruptions, earnings expectations for FY22e and FY23e have been paired back slightly.

With income once again becoming a more important driver of total return this bodes well for domestic investors with Australia amongst the highest dividend yielding markets globally.

The portfolio has a bias towards companies that benefit from economies gradually reopening. Relative to international equity markets we view the local market as being better value, particularly from an after-tax perspective.

Australian Equities

Investment Positioning per Asset Class


A-REITs

The advancement of e-commerce and WFH are the major trends playing out in the Australian property sector.

Consumer and employee behaviour may have changed during the pandemic and been a tailwind for industrial property and a headwind for office and retail.

The “death” of these sectors have been exaggerated, arguing for a diversified approach to listed property.Again, property could be a useful inflation hedge with rental escalations.

We maintain an underweight allocation to North America partly on valuation grounds, but mainly due to a preference for Asia on a medium-term view. However, given the dominance of North America in the ACWI benchmark, portfolios still carry a ~55% exposure to the region.

Overweight allocation to Emerging Markets despite challenges over the last 6-8 months. China has been a headwind for the broader Emerging Market index as slowing growth flows from a reduction in credit growth. Evergrande has not helped sentiment but potentially a necessary event to de-lever the economy for more sustainable long-term growth.

International Equities



International Equities continued

Asia continues to exhibit the long-term fundamentals of structural growth where economies generally enjoy the tailwind of young and growing populations, and led by China, urbanisation and increasing wages are driving the rise of a potentially massive middle class.

This thematic is expected to play out over the years ahead and offer rewarding investment opportunities via companies focused on the local consumer and domestic demand as economies transform from an industrial-led growth model to one focused more on services.

Infrastructure valuations remain reasonable as global economies continue to reopen, albeit at different paces. Increased M&A activity, including for strategic infrastructure assets illustrate the value on offer for investors willing to take a longer-term view.

Preference remains with a strategy diversified across DM's while having a meaningful exposure to EM regions, which aligns with our macro view. Within an environment where inflation risks are skewed to the upside, infrastructure assets often carry CPI linked price escalators providing a hedge against inflation.

Infrastructure



Fixed Income

With low rates on cash and the RBA controlling short-term bond yields curve we prefer fixed income to cash.

We are still not prepared to chase yield given current credit spreads.

Given the defensive role of fixed income, our preference is for managers with a clear focus on capital preservation.

Our concern here is increasing correlations of growth assets and low-yield defensive assets hinders the ability to rebalance portfolios effectively.

Outlook


• Near term market sentiment likely dominated by the Fed starting to taper its QE program (likely November 2021)

• Employment and inflation data will be an area of focus as fiscal stimulus programs roll off and supply chain difficulties play out long than expected

• Positive on the re-opening of economies and wider international movement of people/goods may improve economic data.

• Consumer relief euphoria around increased mobility likely to benefit services (entertainment, travel and hospitality).

• Remain cautiously optimistic, but current market environment is challenging as potential investment outcomes remain wide.

• Unlikely the next 12 months will deliver returns as per the last 12 months.

• At some stage, a pullback in growth assets will occur, predicting when and to what level is near impossible.

• Diversification across and within asset classes continues to be prudent as will rebalancing back to target weights through market volatility.

Macro-Economic Markets

multi-sector portfolio positioning

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