Welcome to our latest investment commentary. This edition will cover the final quarter of last year, and 2023 as a whole. As we head into 2024, we hope you and your family are well.
LOOK BACK AT 2023
2023 turned out to be a choppy, yet positive year for performance. Markets repeatedly wrestled between the ideas of rising and falling interest rates, but 27th October marked the turning point where markets staged a significant rally into the end of the year. We are delighted to report that our performance has been strong relative to the majority of our peer group.
We believe the key to our success was to remain invested despite the multitude of negative headlines and unsettling developments over the year. We in fact slightly increased the risk levels in the portfolios in the middle of October, helping the portfolios capture more of the rally once it started. As we mentioned in numerous communications, we did not know when the rally would begin but evidence suggests that missing the best periods in markets can have a detrimental impact on long term returns.
The trigger for the rally was the markets coming round to the idea that the Central Banks have ended their interest rate hiking cycles. The markets have since aggressively priced in a series of interest rate cuts for 2024, causing an array of asset classes to move higher. We pointed out in several communications that we believed we are close to, or are at, the end of the interest rate hiking cycles seen in the Developed markets, adding to our case of remaining fully invested.
In our previous quarterly commentary, we also said we believed the conditions were there for a positive end to the year. Whilst that became a reality, the rally has far exceeded our expectations. The markets are likely to have a breather and take stock before heading higher this quarter, in our opinion.
Finally, we are pleased to report a further reduction of the ongoing portfolio charges during the year. We have been working hard to reduce these, with the lower charges building on reductions made in 2022.
Much of the quarter was dominated by the significant rally seen in markets. It was initially a weak start, with the weakness in the summer rolling over into October. Bond yields continued to march higher, pressuring the markets, with the widely followed US 10 year Treasury bond briefly reaching 5% for the first time in 16 years. However, that marked the turning point, with some economic data adding weight to the idea that the US Federal Reserve were unlikely to raise interest rates again.
Once again, currencies had an impact. With the markets pricing in interest rate cuts from the US Fed, the US Dollar fell against the Pound creating a headwind for our US Dollar denominated investments. When adding some risk to the portfolios via a US equity index in mid October, we took the view that the Bank of England were unlikely to cut as much as the US Fed in light of the more persistent inflationary pressures in the UK. We therefore decided to buy a currency hedged product to remove the currency risk. This worked well as the US Dollar weakened and Pound strengthened, helping to reduce the currency headwind.
Other than adding some risk, we are pleased to report that we have completed the move from ETFs to index funds as detailed in our fund switch notifications. This should help to reduce any frictional costs moving forwards. We have confidence in the current portfolio composition which has been working relatively well for some time now. We are however considering some new ideas in light of the changing backdrop and will write to you about these in due course.
One of the factors that helped to lead to the rally was the continued fall in inflation data, with year on year US CPI (inflation) falling to 3.1%. Core inflation components also eased back in the recent data releases, which are more of a focus for the US Fed. It was also encouraging to see UK CPI falling materially, with the latest reading at 3.9%. The fall has been even more dramatic in Europe, with the latest reading at 2.4%. These figures are becoming much more palatable for the Central Banks, easing the requirement to raise interest rates again.
Almost all asset classes rallied in tandem, with equities, bonds and Gold moving higher. In contrast to the previous quarter where the FTSE 100 was one of the better performers, it was the FTSE 250 and Small Cap markets that were some of the best performers following the large falls in inflation. To highlight the currency impact, the US S&P 500 index was up around 11% in US Dollars but around 6% in Sterling. Gold did very well, delivering over 11%. The market that did not perform was China, which continued to fall as sentiment remained weak.
Both corporate and Government bonds also performed well over the quarter. But with greater sensitivity to changes in interest rates in our Government bond exposures, they performed particularly well. We have been building exposures to a range of Government bonds for the precise reason that when the markets begin to price in interest rate cuts, they perform well. These exposures are now starting to pay off.
Inflation & Central Banks
For now, it looks likely that inflation data in the developed world will continue to ease. However, the falls will need to stabilise at some stage, ideally around the Central Bank targets of 2%. With the markets pricing in several interest rate cuts this year, this has the effect of easing financial conditions. This may put a floor under developed market inflation data later this year, especially if the Central Banks follow the markets and begin cutting interest rates. We believe they are likely to do so later this year.
However, we also believe there are some others factors that could lead to a rise in inflation.
We are monitoring the energy markets, especially oil. Supply and demand are broadly in balance at the moment however we believe this could tip towards excess demand and therefore higher oil prices. China is showing signs of an economic recovery which in turn would lead to some economic growth in other parts of the world. On the supply side, the US will need to refill its strategic reserves, US shale oil production is falling, OPEC are maintaining supply cuts and tensions in the Middle East could disrupt the flow of oil. In response, we are considering a fund that could help to hedge against this outcome.
In this environment, especially where US growth is slowing, Gold could continue to perform well. We are therefore thinking of ways to enhance our Gold exposure.
Outside of Oil and Gold, we believe our focus on higher quality, large cap companies, should help to navigate such an environment along with our Government bond exposures.
Whilst the economic data has not been as bad as feared so far, we are remaining patient to see how the effects of higher interest rates play out. We continue to expect broader economic weakness in the developed markets as the effects of higher interest rates continue to filter through.
Whilst we have remained fully invested, we have been allocating to an array of protective strategies where possible to protect the portfolios in case of any unexpected outcomes.
Recessions are typically characterised by a cut in interest rates, as Central Banks try to limit any damage and promote economic growth. This will be a trigger for us to begin considering adding more risk to portfolios, where we have some exciting funds in the pipeline.
As mentioned at the start of the update, we have remained fully invested. Some points to note around our thinking moving forwards, which generally follow the comments in our previous updates:
- We continue to believe elevated volatility levels are likely to become a feature of markets over the next few years and so we will maintain a lower volatility approach more frequently. We slightly increased the risk levels recently, which worked well, but may well reduce this again later this year. We are patiently waiting for a more supportive environment in which we expect to add risk to capture more of any positive returns.
- We are now being rewarded via our Government bond positions, which we have been steadily building in anticipation of an end to the interest rate cycle. These can act as an effective hedge against equity market volatility. We expect these investments to perform for us during 2024, and possibly into 2025, at which point we will look to sell them in favour of other alternative strategies.
- Outside of Government Bonds, we have maintained our exposure to short-dated investment grade bonds, which are the safest corporate bonds to invest in. The yields remain attractive and this part of the bond markets has continued to perform well.
- In terms of our equity allocations, our largest equity exposure remains towards US markets however, we are maintaining good allocations to other markets such as Asia. Diversification is key in this environment and with this in mind, we are exploring investments related to energy and Gold.
- We continue to have no direct exposure to Europe due to the ongoing war in Ukraine. On a look through basis, some of our global funds have select European exposures and these are typically in the high-quality international companies.
- We have no direct exposure to Japan at this stage but are monitoring the markets and are seeking an entry point. It’s likely we may see this after the Bank of Japan normalises monetary policy. We believe Japan’s longer term outlook looks attractive.
- Our UK exposure has changed a little, with smaller companies very gradually being increased in light of the falling inflation backdrop. Much of our exposure remains in large, international FTSE businesses. We are monitoring this and believe an opportunity will come along eventually to add to our smaller companies.
- We continue to hold a reasonable amount of Asian equities and are thinking to expand into other Emerging Markets. Valuations are very compelling and they generally do not face the same inflation/interest rate policy headwinds. In fact, many Emerging Market Central Banks were quick to tame inflation and are now in a position to begin cutting interest rates, which can be a major positive. Whilst sentiment towards China has been weak, we believe this will turn around at some stage, possibly in the first half of this year. We would not be surprised if China outperforms this year and have maintained our exposures.
You should note that when we see signs of improvement and the potential for interest rates to fall, we are likely to increase our risk levels and focus on areas that typically do well during the recovery periods such as Financials, Industrials and Materials businesses.
We are pleased with our 2023 performance and continue to monitor the fast-changing developments. We are patiently waiting to see how things play out and are considering investments in energy and Gold.
We will continue to look for new opportunities for the portfolios whilst trying to navigate the environment the best we can.
We hope you find this review informative and look forward to hearing from you if you have any questions.
IMPORTANT: This publication has been prepared for information purposes only by Carrington Investment Consultants Ltd. 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. Carrington Wealth Management is a trading style of Carrington Investment Consultants Limited which is authorised and regulated by the Financial Conduct Authority. Registered office: One Chapel Place, London W1G 0BG. Registered in England, number 3193939. This email and any accompanying documents contain confidential information intended for a specific individual which is private and protected by law. If you are not the intended recipient, any disclosure, copying, distribution or other use of this information is strictly prohibited. You are also requested to advise us immediately if you receive information which is not addressed to you. Data Source: Financial Express. Copyright © Carrington Wealth Management. All rights reserved.