2022 will be another exciting year for financial markets. Investors operate in an environment of persistent inflation, foggy central bank policy and uncertainty about the Omicron variant. It is a search for yield and protection in the portfolio. But how?
Charles-Henri Kerkhove, investment director at Fidelity’s Multi Asset team in Frankfurt, said he believes that 2022 will be a turning point. In an interview with Fondsnieuws (Investment Officer Luxembourg’s sister publication), he stated that there are three important things to keep an eye on. These are the policy path of the Fed and the ECB, the course of the Chinese government and the effect of the Omicron variant.
“There is tension in the bond markets in particular. Last year we already saw a reaction there,” Kerkhove said. “It was a year of negative performance (in local currency) for both European and US government bonds. This year, I expect bond markets to be even more volatile.”
According to Kerkhove, there is a growing intention among central banks to reduce “abnormal” policies to normal proportions. “There are more and more proponents within the Fed of winding down the buy-back programmes more quickly than initially announced and of raising interest rates,” he explained. “The ECB, however, is somewhat less energetic - for the time being. Both bond and equity markets could turn if the “discourse” of both the FED and ECB changes in terms of the speed at which they normalise their policies”.
Tactical opportunities
While Kerkhove acknowledged that government bonds remain a difficult asset class, he believes there are a number of nuances and tactical opportunities that are important with regard to multi-asset investments.
“The most sensitive are US government bonds. Then comes the European market, because the ECB is a bit more cautious. In terms of government bonds, Chinese bonds (with a yield of 2.8% for 10-year bonds) remain our preference. It is one of the few markets where government bonds still give a positive return after inflation.”
“The correlation,” he continued, “between Chinese and Western bonds is relatively low and I expect the Chinese government to focus strongly on financial stability this year. There, the government is concentrating explicitly on regulation and reducing financial market slippage. We have minimal weighting in European government bonds that are interest rate sensitive.”
What impact the Omicron variant will have on financial markets is crucial, according to Kerkhove. Markets reacted laconically to the new variant, despite high contagion peaks, so that 2021 also saw a positive year-end. If that sentiment tilts, it could have a positive effect on government bonds.
Where to hide?
“The key question is how to build protection into the portfolio at a time when adding defensive assets is becoming increasingly complicated. At Fidelity, we look for alternatives, such as Asian high-yield investments and defensive currencies such as Swiss francs and the Japanese yen. Banking sector and commodity stocks are also interesting at this stage of the economic cycle,” said Kerkhove.
In addition, Kerkhove’s team has gradually reduced the weighting in high-quality corporate bonds, which will be under pressure in an environment of rising interest rates. High-yield bonds are therefore his preference, especially in Asia where yields provide enough ‘cushion’ for investors.
In addition, Kerkhove and his team use so-called “long-short strategies”, absolute return strategies and specialised real estate and infrastructure strategies where they invest in wind farms and renewable energy. “There, income is often linked to inflation and less sensitive to the economic cycle.”
Holding a lot of cash in the portfolio is not particularly interesting, according to Kerkhove. “Cash is a dead weight in the portfolio. Responding to the market with cash requires good timing and that is very difficult.” A bit of cash is useful if you want some tactical “firepower”, but there are always enough performance differences between markets not to need to hold huge amounts of cash, he argued.
Fidelity’s Multi Asset team manages $58 billion (end of December 2021). The FF Global Multi Asset Income is Fidelity’s flagship fund with $10.4 billion in assets (ISIN: LU1116430247). This fund emphasises flexibility, diversification and defensiveness and invests in income-generating asset classes. The performance for the Accumulation Euro share class in 2021 was 9.7 per cent after expenses. The three-year return to the end of 2021 was 19.6 per cent.
Interest rate hikes
According to Hans Betlem, CIO at IBS Capital Allies, the expected interest rate increases will not help because interest rate increases are not the solution to the supply problems caused by the pandemic. Betlem is not worried about a possible interest rate rise. “Since 1950, we have had 16 periods in which the long-term interest rate on US 10-year government bonds rose by 1 percent or more.”
“Only two of those periods,” Betlem continued, “resulted in a negative return for equities. On average, the S&P 500 returned 11.9 per cent per year. It is therefore a misconception that there is a correlation between rising interest rates and the negative performance of the stock market,’ says Betlem. “For the time being, we are quiet in the equity market. We are looking for companies with pricing power such as Microsoft and Adyen. With those titles in the portfolio, you don’t have to worry so much about inflation and interest rate rises. They can easily calculate all those macro-economic variables.”
No need to switch
Deferring to alternative investments such as commodities is not a good strategy, according to Betlem. Real estate and private equity may be, but they do not add any diversification benefits. According to Betlem, real estate is an interest rate game at the end of the line, and private equity (despite the absence of a daily rate) is still strongly correlated to shares.
As far as commodities are concerned, the chances are slim, according to Betlem, because price rises there fuel human ingenuity. “Then we come up with new technology. To make money from raw materials, you need perfect timing and nobody usually has that. If you had invested in commodities for the last 100 years, you would not have made any money.”