Welcome to our latest investment commentary covering the third quarter of 2021. We hope you and your family are well and have had an enjoyable summer.
This update provides some in-depth commentary on the markets and our views moving forward.
Q3 2021 REVIEW
Market Performance
The third quarter got off to a good start in continuation of the strong upward move seen in the latter half of Q2. However, market weakness emerged in the Asian markets in July and then the developed markets in September. This led to the portfolios delivering flat to slightly positive returns over the quarter, with the best performer being our Sustainable Growth portfolio, which posted a 1.7% gain.
Kicking off with Asia, and specifically China, the authorities there began a crackdown on what they deemed to be “excesses”. As with the Western world, the pandemic has led to greater income and wealth inequality in China. With the upcoming Communist party reshuffle in 2022, President Xi has led the charge against these excesses by clamping down on certain industries such as the online education sector, which he believes should be a non-profit operation. This was followed by nerves around the Chinese property sector, and specifically the largest operator there, Evergrande. The company has amassed debt in excess of $300bn and has defaulted on some of its loans.
The combination of these two events alongside slowing growth in China began a sizeable market correction in the region. This spilled over to the Developed markets somewhat which was then exacerbated by concerns around inflation.
In a repeat of the events seen in Q1 this year, inflationary concerns resurfaced as the price of natural gas and oil marched higher which in turn pushed bond yields higher. At the time of writing, Natural Gas has seen a six fold increase in price this year. Brent crude oil has crossed through $80 a barrel for the first time since 2018. You may recall Brent crude futures contracts fell below $0 a barrel just 18 months ago as demand dried up. In our previous note, we mentioned the possibility of inflationary concerns creating volatility during this quarter and it did not disappoint.
Future inflation expectations have risen off the back of these developments and UK CPI (inflation) hit 3% last month, although this has been exaggerated by the base affects from last year where energy prices were very low.
The recent volatility has impacted most asset classes, with equities, bonds and Gold all falling together. There has been a degree of rotation, with sectors such as Technology underperforming economically sensitive sectors such as Banks although most sectors did fall. You may recall in our January 2021 webinar that we spoke of the risk of correlations rising this year, prompting us to reduce our bond exposure in favour of hedge funds which we felt could offer better diversification benefits. Our largest hedge fund exposure is to the KLS Arete Macro fund, which has delivered 7% this year vs the main global bond index (Barclays Global Aggregate Bond) returning -3.6% so far in Pounds Sterling.
The Central Banks have also played their part, with the US Federal Reserve (the Fed) indicating they are likely to begin tapering their monetary stimulus programme in the next few months and that they could begin to raise interest rates as soon as next year. These potentials are also something we spoke of in our January webinar, adding further evidence to reduce our bond exposure. More recently, the Bank of England have begun to echo the Fed with a slightly more hawkish tone.
Portfolio News
Since we felt there was the potential for bond yields to rise again in the latter part of the quarter, we did reduce our exposure to growth-orientated sectors such as Technology and increased the economically sensitive sectors such as Banks towards the end of August. In a rising bond yield environment, economically sensitive sectors tend to outperform. Where applicable, we did also increase our exposure to inflation-related ETFs. Given the ongoing volatility in Gold, we also reduced our exposure to Gold slightly.
We have previously mentioned our exposure to the Tabula US Inflation ETF in which we have built a large position for a number of portfolios. We are pleased to say this is our best performing bond holding for a third quarter in a row this year and is the best performing inflation product we are aware of on the market. The ETF is now up 11% this year compared with the Barclays Global Aggregate Bond index returning -3.6% in Pounds Sterling as mentioned earlier.
In aggregate, the portfolios have performed relatively well this year and have delivered mid to high single-digit returns so far.
OUTLOOK
Inflation
The inflationary outlook suggests we may have generally higher levels of inflation into next year. We are seeing wage inflation in a number of sectors and of course higher energy prices. However, we are likely to see this fluctuating over the next few quarters. As mentioned, energy prices have seen a dramatic rise. This is usually not sustainable and the probabilities now favour a short-term decline which will help to alleviate the inflationary concerns. President Putin has stepped in to ease natural gas prices and we are likely to see OPEC increase the oil supply.
Higher energy prices are however likely to persist into next year which could pressure the markets in 2022.
On a longer-term view, it is worth noting that the pandemic has accelerated the digitalisation of a number of sectors. Digitalisation is actually deflationary and so whilst there are concerns about the short-term outlook, the odds are tilted in the opposite direction over the longer term.
Markets and The Thematic Approach
Given the inflationary backdrop, we are likely to see ongoing volatility across sectors, particularly those exposed to long-term growth themes such as Technology, Biotech and Renewable Energy. For the remainder of the year, we expect the inflationary concerns to ease which should help the markets perform well. We, therefore, expect a positive end to the year for markets and these sectors in particular.
We continue to believe that the long-term trends and themes we have previously discussed, such as the shift to ESG investing, will continue to reassert themselves. We still expect economic growth in the Developed markets to fall and normalise to pre-COVID levels from next year. Since the Asian economies have already been through this process, it is possible that Asian markets will outperform the Developed markets during the first half of next year.
Summary
Whilst we have again seen some volatility at the sector level this year and across the markets more generally, the portfolios are well-positioned to navigate the potential environment 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 finish the year on a positive note. The end of the year is seasonally positive for markets and we are hopeful to see a “Santa” rally again this year.
There are some minor adjustments being made to a few portfolios but otherwise, we currently do not have any plans to make any further amendments this quarter. Given the weakness in the Asian markets, we will be introducing our first Asian fund in the Sustainable Growth portfolio shortly.
MARKET INSIGHTS WEBINAR & VCT UPDATE
If you missed our investment webinar, Mo gave us an update on Q3 and our thoughts going forward and Alistair introduced us to VCT’s, their benefits, and a few of the offerings we like. Click HERE to watch the recording.
We hope you find this review informative and look forward to hearing from you if you have any questions.
This publication and the webinar recording have been prepared for information purposes only by Carrington Investment Consultants Ltd t/a Carrington Wealth Management and do not constitute financial advice. 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.
