After a relatively strong year for equities, buoyed by continuing government and central bank fiscal and monetary support, more recent concerns around inflation, interest rate increases, the unwinding of quantitative easing, and the reduction of growth combined with increased regulation in China has caused unease to both equity and fixed income markets over the past few months.
Towards the end of September, the Guardian portfolios trend-following signals recommended to sell completely out of emerging markets and a small percentage out of the Pacific. We further reduced our Pacific holdings at the beginning of October. These changes have allowed the Guardian portfolios to weather the equity losses in these markets.
This week, after some of our shorter signals recognised a rebound in emerging markets, we re-entered emerging market funds cautiously. Although there is continuing concern around Evergrande, it is widely expected that this risk will be limited in scope and not cause contagion throughout China’s economy. Growth in China has slowed, but government regulations which have been put in place are intended to help China become a more developed economy. The Chinese government’s aim to create common prosperity by 2050 focuses on property, education, and health care. Future government policy is more likely to be used to prevent systemic risks while allowing some over leveraged companies like Evergrande to unravel in a controlled way.
The unit trust index tracker funds which we have been using for our Pacific market asset allocations have tracked the FTSE World Asia Pacific ex Japan and the FTSE Developed Asia Pacific ex Japan indices. Although these funds have both performed well over the past few years, they have more recently had similar losses and both have a similar, slightly higher allocations to telecoms, media, and technology. We decided to replace one of these funds with an MSCI Pacific ex Japan Index tracking fund, to provide further diversification and because this fund has had strong trend-following recommendations suggesting to buy along with better performance in the past 6 months. We have therefore decided to swap into this fund while continuing to follow the trend recommendations to remain a percentage out of one of the original Pacific funds.
There has also been a slight dip in Japanese equities. We have had a signal to moderately reduce the allocation for one of the two funds in which we are invested, and we have also actioned this change this week.
Fixed income funds have struggled over the past few months with concerns about rising inflation and the timing of interest rate rises by both the Fed and the Bank of England. We moved our allocation to shorter dated investment grade corporate bonds and inflation linked bonds towards the end of last year and the beginning of this year. Over the summer we further reduced the longer-duration allocations and added a short dated high yield bond fund and the Aegon Strategic bond to help manage the turbulent bond conditions. As we believe equity markets may continue to be volatile and we may continue to have an increased frequency of trading, we have decided to remove both the Aegon Strategic bond and the Rathbone Ethical bond funds due to high transaction costs and higher OCFs. We have replaced these funds with a very small allocation to a sterling inflation linked bond and two target return funds.
Short-dated investment grade bonds have also struggled over the past few weeks with trend-following signals recommending to exit these positions. In the US, there is an expectation that the Fed will announce that they will reduce quantitative easing, followed by an increase in interest rates in 2023, after the reduction in quantitative easing has completed. Alternatively, in the UK, the Bank of England is relatively more hawkish and could raise interest rates as early as November due to inflationary concerns and before any change to the levels of quantitative easing. An increase in interest rates will cause a direct decrease in short-term bond prices and depending on expectations could also impact longer-dated bond funds. We have moved the short-dated investment grade bond allocations and the extra equity allocation assigned to these funds to cash in our step-down risk approach.
We continue to review our fund’s returns and trends every week and have at least fortnightly investment committee meetings to aim for timely exits and re-entries into both the current falling and rising markets. We always aim to achieve Guardian’s core principles to minimise volatility while capturing the majority of upside performance.
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