Welcome to our latest investment commentary covering the second quarter of 2021. We hope you and your family are well and are looking forward to the prospect of some normality returning in the near future.
This update provides some in-depth commentary on the markets and our views moving forward.
Q2 2021 REVIEW
The second quarter of the year was characterised by a story of two halves, largely led by the prospect of rising inflation. During the first six weeks, inflationary fears began to take centre stage as inflation data (CPI) in the US rose to a year on year rate of 4.2% in May. It had already been gradually rising, but this figure exceeded expectations. The inflationary fears led to a renewed rotation from the growth sectors to those that are more cyclical.
However, at the halfway point in the quarter, we then saw a strong “reverse rotation” with growth sectors materially outperforming into the end of the quarter. We felt the current inflationary story was priced in and the strong recovery in the growth sectors confirmed this. Further evidence was provided by the US CPI print in June, which was 5% year on year. This should have led to the growth sectors performing poorly but they actually began to outperform following the news. This was helped by the US Federal Reserve (Fed) indicating they may raise interest rates sooner than expected, suggesting the risk of inflation getting out of control was now lower.
Whilst there was a lot of hype around the inflationary story, we felt that at least in the near term, the inflationary pressure will abate because it was driven by supply and demand imbalances. In short, the easing of restrictions in many countries has led to a large rise in the demand for goods and services. Suppliers have been unable to meet this demand, causing the input costs of a wide range goods to rise. We did not feel this was sustainable, with suppliers likely to restock and demand likely to ease as we get used to the lifting of restrictions. There were also several technical factors to support our view. We therefore decided not to add any more exposure to the cyclical sectors which worked well for our portfolios in the end.
Given the main US markets are more exposed to the growth sectors, especially Technology, they have continued to move higher and have repeatedly made new highs this year. The UK markets have had another good quarter too, particularly the small and mid cap areas, leading to good returns in 2021 so far.
Since we have talked about the pandemic on a number of occasions over the past 15 months, we did not want to spend too much time on it in this update. The Delta variant is clearly proving to be an issue for some countries and whilst infection rates are climbing in the UK, the large adoption of vaccines is so far demonstrating reduced numbers of hospital admissions. The markets are not really responding to Covid related news now.
As stated in the market update, there was not a lot of activity in the portfolios over the quarter.
You may recall in our previous quarterly note that our UK smaller company funds were performing well. This led us to rebalance the portfolios at the end of Q1 to lock in the profits. Those funds have continued to move higher, with the Chelverton UK Growth fund now up 24% this year and the Liontrust UK Micro Cap fund up 32%. We purchased the Liontrust UK Micro Cap fund for our Growth portfolio in October 2020; the returns since then have been +55%. These are exceptional returns in such a short space of time. Following conversations with the managers of the funds, we felt it was sensible to reduce our allocations to the funds in favour of larger cap UK companies. Once valuations normalise, we will look to increase our allocations again.
We have owned the Federated Hermes Global Emerging Markets fund across several active portfolios since 2016. The fund has performed well over the years and has won a number of awards. As a result, they began to attract a lot of money which started to concern us. Hermes eventually confirmed earlier this year that they were soft closing the fund and after an extensive period of research, we replaced it with the Fidelity Asia Pacific Opportunities fund.
We have stated in previous communications that we are not particularly keen on bonds with a long term view. We have maintained some very selective exposure and built a large position in the Tabula US Inflation ETF for a number of portfolios. Whilst we did not feel inflation would persist in the near term, we felt we needed to hedge the risk using a product like this. We are pleased to say this is our best performing bond holding for a second quarter in a row this year. The ETF is now up 6.5% this year compared with the main global bond index (Barclays Global Aggregate Bond) returning -3.1% in US Dollars.
In aggregate, the portfolios are performing well this year and have delivered mid to high single digit returns so far. Our highest risk portfolio is up around 8% so far.
We have mentioned inflation a few times in this update and that on a short-term view, we think the inflationary pressure will abate.
However, we need to be mindful of other factors at play that could lead to a resurgence in inflation. The labour market is seeing wage inflation as the need for workers has risen as economies open up, but the number of people seeking work has not followed suit. There are several thoughts as to why this is the case but whatever the reason, employers are having to raise wages in order to attract workers. This is being seen across a number of industries. Good economic growth and greater spending power could lead to an upward spiral of inflation over the next few years, particularly in the US. This is likely to be a story for 2022 but we are keeping this in mind and assessing the potential knock on effects.
It is possible that this story could create some volatility in Q3.
Markets and The Thematic Approach
As we mentioned in our previous outlook, we did not believe the rotation to the cyclical sectors will persist and that the themes within the portfolios will reassert themselves. This has certainly been the case with areas such as Cloud Computing and Health Innovation performing strongly.
We continue to believe that the long-term trends and themes we have previously discussed, such as the shift to ESG investing and the uptake of renewable energy, will continue to reassert themselves. We expect economic growth to normalise and return to pre-COVID levels, which in turn will be supportive of the themes discussed.
As we moved in 2021, we started to talk about the potential for a taper tantrum at some stage in late 2021 or 2022. A taper tantrum is an event where the Fed begin to tighten financial conditions to an extent not expected by the markets. The last time we saw this was in 2013 and led to a fall in both the equity and bond markets.
Apart from expecting little in the way of returns from the bond markets, a potential taper tantrum was another factor that led us to reduce our bonds and increase our hedge funds, potentially leading to better diversification benefits in the active portfolios. The recent signals from the Fed may have reduced this risk but the potential remains and so we are focussed on ensuring sufficient levels of diversification are present in the portfolios.
Whilst there has been some volatility at the sector level this year, the portfolios are performing well and we remain positive about the medium-term outlook for the markets and the structural growth sectors we have mentioned over the past year. As always, there are some risks that need to be kept in mind and mitigated, but we believe markets will continue to move higher this year.
We will be making some minor adjustments to a few portfolios and so please keep an eye on your inbox for the switch notes.
Is the Inflation story sustainable? Join Mo and Tommy for our next investment webinar on the 14th July at 13h00. They will be discussing this hot topic, its impact so far this year and our outlook for the remainder of the year. Please click HERE to register.
We hope you find this review informative and look forward to hearing from you if you have any questions.
This publication has been prepared for information purposes only by Carrington Investment Consultants Ltd t/a Carrington Wealth Management. The value of investments, and any income generated from them, will be affected by interest rates, exchange rates, general market conditions and other political, social and economic developments, as well as by specific matters relating to the assets in which it invests. Investors should be aware that the value of units may well fall as well as rise, is not guaranteed and that past performance is not a guide to future performance. Different funds carry different levels of risk and investors may not get back the full amount invested.