Our portfolios provided disparate returns over the month, with the shorter duration portfolios affected by poor market conditions for bonds and cash – which were challenged by inflationary surprises. Our longer duration and more diversified portfolios provided positive returns as our inflationary positioning benefitted the portfolios.
Inflationary concerns have risen in recent months with supply chain issues persisting and other inflationary issues growing. The bond market has become concerned about inflationary pressures challenging unsustainable central bank policy, along with the risk of another economic slowdown.
We remain concerned about medium-term market and economic prospects including the risk of stagflation, inflationary pressures persistently, deflation without further stimulus, geopolitical risks, ongoing challenges to real growth and sustainable profitability, and highly elevated market valuations, and are hence participating selectively in risk assets. The greatest medium-term challenge for all portfolios is probably achieving returns without suffering unduly in future market crises as the reality of our challenged economic circumstances becomes an issue again. We are seeking to mitigate risks such as these and inflationary pressures in part by avoiding the worst of the market exuberance and with meaningful alternatives and selective commodities and resources allocations.
We continue to see the need for strong active management to produce acceptable risk/return trade-offs.
We continue to look to diversify the portfolios where appropriate and sensible. We continue to believe some meaningful exposure to assets such as precious metals are essential as a hedge to navigate the coming months if governments continue to provide massive stimulus and inflationary pressures continue. Our non-consensus position here has begun to be rewarded again in recent times. We note that economic and political risks remain very elevated globally with a real risk of future conflicts.
Our Cash Plus portfolio is very 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.
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 the most leeway to back higher risk assets on the basis of our insights and research, while still managing risk prudently over a longer-term time frame; it is in many ways a flagship portfolio for DAC and has – along with our other portfolios - proven highly competitive with both liquid retail and institutional portfolios of a similar nature. Active management in general has become more productive since COVID, despite large flows to more passive instruments.
DAC’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. 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 are much more forward-looking than a historical SAA approach which tends to be much more biased to what has happened (for example, by relying more upon past correlations and volatility - which may be markedly different from the future). We consider future scenarios actively and if there is a major regime shift - such as towards inflation rather than disinflation - our approach and portfolio should be much more effective. That said, the market outlook remains challenging for everyone currently, no matter what the approach.
Extraordinary monetary and fiscal stimuli have been implemented by central banks and governments, creating distortions and market interference. The sheer size and extent of their actions is providing meaningful impacts on market returns and, in many cases, causing substantive dislocations from underlying company and economic fundamentals. Over time, we expect these policies to be very supportive for certain portfolio positions and require dynamic management of others. For example, and in particular, we hold meaningful weightings to ‘hard assets’ in different guises, and continue to expect these to provide valuable return and risk contributions over time, even if they are occasionally volatile. We believe large and unsustainable debt burdens, poor government policies and market interference continue to strangle real productivity growth for much of the economy, albeit nominal growth has markedly improved. This potentially bodes relatively poorly for traditional risk assets and index investing, upon which most traditional investment strategies and super funds are heavily dependent. Furthermore, we think good active managers will better be able to differentiate themselves and add value over the next few years, in part by being more nimble and able to differentiate between assets based upon their prospects in different economic circumstances and very disparate valuations.
We continue to be concerned about asset prices. We believe growth outcomes, geopolitical tensions and other risks and shocks pose further (unanticipated) risk to markets, potentially just as coronavirus has. Indeed, it may take a market shock to end the current market rally given many investors appear to have become entirely valuation insensitive in the face of massive stimulus. We hence think investors are best served by thinking outside the box in order to better protect and grow their capital, including potentially greater use of liquid value-adding alternatives (selectively chosen), discounted listed investment companies (selectively chosen and now more difficult to identify), along with precious metals exposures and greater weightings to real assets.
We aim to remain astute and flexible and highly risk-aware and are invested in liquid assets whose weightings we can adjust over time to respond to an ever changing and potentially highly challenging investment climate.