We had mixed performances in our portfolios in May. We continue to emphasize genuine diversification at a portfolio level and keeping equity weightings low ahead of a possible hard landing in the economy and equity markets, given the significant risk of this occurring. History backs our position. Chasing markets and investing too fully in risk assets at this stage of the economic cycle – as we believe many are doing - is fraught with risk and it’s likely they won’t be able to take advantage of any market weakness to boost returns when the opportunity arises. There is noticeable market crowding again in large global technology names based on the exciting AI theme, which may lead index-like investors to significant disappointment as the year progresses as these stocks appear to have run ahead of earnings delivery.
Real economic and earnings growth will likely become weaker given current monetary policy settings and into a likely recession or softening economy at the very least. This may begin to be priced into markets as persistent central bank tightening and structural challenges impact markets with a lag. Given the macroeconomic backdrop, this would likely provide an outstanding opportunity for our portfolios to shine over the next year and two.
Given our medium-term outlook, we see the need for some alternatives, precious metals and other commodities in portfolios and a more diversified approach than what is commonly relied upon by other investment managers. Precious metals tend to do very well in recessions comparatively. We believe that the coming years will provide significant opportunity for us to benefit from our positioning in real assets and our investors will be rewarded for sticking with our fundamentals based approach at this important time.
Our Cash Plus portfolio is defensively positioned, while our Short-Term portfolio is relatively defensive, with both designed to be less volatile over shorter term time periods than our longer duration portfolios –being designed for shorter term liquidity needs. Higher cash rates have significantly improved the prospective returns and relative risk/return outlook for these portfolios. Short-Term in particular may be attractive to some investors who are wanting to be very defensive with their longer-term money.
Our more medium and longer term orientated portfolios target returns and manage risk with longer term time periods in mind. The Wealth Builder’s larger risk tolerance gives us most leeway to back various risk assets on the basis of our insights and research, while still managing risk prudently over a longer-term time frame through dynamic asset allocation. We do however remain relatively conservatively positioned in these portfolios for now given prominent equity market risks but believe that the outlook for the stocks we do hold and our commodity positions over the medium term to be excellent. In particular, many commodities appear to be likely to suffer from undersupply in coming years unless a recession is very protracted (a protracted recession is unlikely in our view given likely policy settings should a recession occur). In contrast, some stocks such as current market darlings in AI, are priced for perfection today and we are avoiding them in contrast to most of the market which is chasing them ever higher in price.
Dynamic Asset’s portfolios are designed to be diversified, but focus on investing where return prospects are assessed as capable of meeting the return objectives of the funds over their respective time horizons and in reasonably priced assets. This diversification provides useful mitigation against risk over the appropriate time period consistent with each portfolio’s objective, while our active assessment of risk and return can target capital to where it appears most prospectively and appropriately placed. In this way, we believe we are much more forward-looking than most diversified managers which tend to be much more biased to industry peers and what has happened (for example, by relying more upon static weightings, and past returns, correlations and volatility - which we believe are markedly different from today’s conditions).
We are better diversified than many other investment managers because we hold meaningful weightings to alternatives and ‘hard assets’ in different guises and expect these to provide valuable return and risk diversification over time in our portfolio context, even if they are occasionally volatile individually. We believe large and unsustainable debt burdens, demographics, poor government policies and market interference continue to strangle long term real productivity growth for much of the world economy, although AI may provide some relief and competitive benefits for some businesses over time.
We are very concerned by geopolitical risks and the massive challenges to the previous period of globalisation and peaceful prosperity. The increasing risk of major conflicts gives further credence to our concerns. We think investors are best served by researching thoroughly and thinking more broadly and outside the box in order to better protect and grow their capital, including potentially greater use of selectively chosen value adding liquid alternatives, along with precious metals exposures and greater weightings to real asset proxies. We expect precious metals to do very well comparatively in recession and are maintaining our meaningful positions for this reason.
Over the last year we have increased our positioning in high quality credit, bond and cash as we want to provide relative protection in the (not unlikely) event of a hard-economic landing - rather than the goldilocks scenario that the market is currently pricing and which is possible but unlikely historically given central banks fight against inflation. Over time we expect volatile inflation outcomes will better serve our more diversified portfolio’s positioning - including our real asset and commodity positioning – than the more narrow and less differentiated traditional portfolios. The latter is much more dependent currently on equity performance alone outperforming historical comparisons, which while possible is a gamble.
We aim to remain astute and flexible and highly risk aware in an ever changing and potentially highly challenging investment climate and will continue to look to take advantage of our research effort and the volatility, uncertainty and irrationality of markets to add value to the portfolios through time.