There’s no such thing as a risk-free lunch. Whilst your writer may well have distorted a much-revered Milton Friedman phrase, 2022 has proven to a be a year where risk free assets, government bonds, have proven to be as risky as most equity markets.
In this update, we take frame at investment returns in 2022 versus history, how the risk-targeted CT MM Lifestyle range has fared in this environment, provide an overview of asset allocation and cast our eyes forward to 2023.
Low risk ≠ safe return in 2022
Inflation has long been touted as the kryptonite to low yielding assets. With inflation approaching levels in 2022 not witnessed during the past 20 years and the starting point for government bond yields close to all-time lows, fixed income assets have re-priced to levels unseen in the post-financial crisis era.
Many diversified multi-asset portfolios operate from an underlying starting point of holding government bonds to hedge the more volatile characteristics of equities. A standard 60:40 balance of bonds and equity returns over time (see chart 1) shows 2022 is shaping up to be the worst in the past forty years, but for the global meltdown of 2008.
More recently, the UK government’s mini budget poured petrol on an already burning UK bond market, exacerbating the selloff year-to-date, with large unfunded tax cuts. Such policy saw the end of Liz Truss’s record short Prime Ministership and has placed borrowing costs, through bond yields, as the go-to measure of the governments’ record in fiscal responsibility.
Annual Returns for a 60:40 portfolio
Source: 19th October 2022, LCI UK Balanced 60:40 Index, Lipper for Investment Management
In context - understanding the performance of the CT MM Lifestyle range
Despite recent moves, we are firm believers that taking risk should, and mostly is, rewarded over the long term – simply put, equities on average deliver more positive returns than they do not. If we review the CT MM Lifestyle range through time, the risk levels chosen by an investor correspond well with the level of return generated (chart 2). This correlation between risk level and associated return has almost completely broken down in the short term. As a reminder the CT Lifestyle fund range uses Dynamic Planner’s strategic asset allocation as a starting point, and as a result of the consummately larger weight of fixed income in the lower risk levels, Lifestyle 3 has delivered a larger negative return year-to-date than that of Lifestyle 7 (chart 3) – atypical in falling market.
Aligned risk appetite and outcomes
Source: 19th October 2022, Lipper for Investment Management
2017 | 2018 | 2019 | 2020 | 2021 | |
|---|---|---|---|---|---|
CT MM Lifestyle 3 B Inc | 5.2 | -3.1 | 9.2 | 3.4 | 4.0 |
CT MM Lifestyle 4 B Inc | 7.9 | -4.5 | 11.9 | 4.0 | 7.7 |
CT MM Lifestyle 5 B Inc | 11.1 | -5.9 | 14.2 | 4.1 | 10.6 |
CT MM Lifestyle 6 B Inc | 14.2 | -7.6 | 15.6 | 2.9 | 11.2 |
CT MM Lifestyle 7 B Inc | 17.2 | -9.6 | 17.0 | 1.7 | 12.6 |
Source: 31st December 2021, Lipper for Investment Management
The impact of the bond selloff
Source: 19th October 2022, Lipper for Investment Management
Whilst negative performance for clients is always disappointing, we have taken a number of steps through 2022 to shelter portfolios from market turmoil. Using Lifestyle 3 as an example, we have held an underweight to fixed income through 2021 and into 2022 (chart 4). We actively extended this underweight through the turn of the year as, in our opinion, inflation was proving less ‘transitory’ than markets were expecting. We further diversified our overall bond exposure through using other instruments such as using iShares USD TIPS UCITS ETF and iShares USD Treasury Bond 1-3yr UCITS ETF, both containing bonds much less sensitive to interest rates and away from UK-centric issues.
Adding back to fixed income
Source: 19th October 2022, Columbia Threadneedle Investments
Have we passed peak bond pain?
The back up in bond yields has been so severe that we now see a rare opportunity within fixed income. We have recently initiated positions in Artemis Short-Dated Global High Yield Bond Fund and Man GLG Sterling Corporate Bond Fund, across our Lifestyle range, with both managers having strong track records in periods following stressed markets. In addition, we have increased our weight in Allianz Strategic Bond Fund, with manager Mike Riddell recently citing this to be the best opportunity to own government bonds in his investment career, we spoke to him on our recent podcast found here
A cheaper lunch for equities needed
However, rising borrowing costs creates a headache for most other asset classes, particularly those which use debt to bolster their performance returns. Throughout the summer we reduced our property exposure to underweight and away from funds characterised as having elevated Loan-to-Value ratios.
With corporate profit margins and earnings still at elevated levels after large post-COVID expansions, we feel particularly nervous for equities still. We have further increased our underweight to equities, which now sit at record lows since we began managing the Lifestyle portfolios in 2011 (relative to Dynamic Planner benchmarks). We hope to add back to equities at cheaper valuations as we move into 2023, once we see market levels more appropriately reflect the risks outlined, or our concerns dissipate.
For now, we feel more comfortable picking up the superior yields in an already dislocated bond market, which in our opinion are not too dissimilar to our long-run expectations for equity returns.
