Q1 LF Prudential Risk Managed Active and Risk Managed Passive Funds Investment Update
- Inflation concerns the major theme in the first quarter
- Despite renewed national lockdowns, the global economic recovery does not appear to have been blown off course
- Commercial property continues to recover
- A good quarter for equity holdings, more challenging for corporate bonds
- Tactical overweight positions maintained across
the main equity markets and emerging market bonds
The major story of the quarter was the activity in fixed income markets, driven by inflation concerns, as many mainstream government bonds sold off, led by US Treasuries.
President Biden’s US$1.9 trillion COVID-19 relief bill was passed in early March, raising short-term growth expectations for the US economy, but also raising the prospect of higher inflation.
Investors became fearful that the US Federal Reserve may eventually have to act a lot earlier than anticipated to stifle inflation given the massive extra stimulus package, the third in the US since the pandemic. The yields on US 10-year government bonds rose significantly as investors sold their holdings.
The portfolio managers believe the widespread vaccinations and rising commodity prices alongside the large stimulus package in the US could cause short-term increases to inflation.
There are also logistical challenges caused by the pandemic, with planes and containers in the wrong places and borders being closed, all of which could cause prices to spike in certain goods, although over time, as capacity builds up and supply chains are re-adjusted, these challenges should fade.
Looking longer-term there are four factors that the team believe have kept inflation low;
Independent, inflation-targeting central banks
Technology has weakened the pricing power of firms and undermined the bargaining power of employees
Globalisation and competition in global markets, particularly the introduction of China to the world economy, has limited wage and price increases, although both the pandemic and more nationalistic economic policies could start to reverse this
Demographics, an increasing share of populations able to work, particularly the 30-64 age range, often means greater productive capacity relative to demand, hence lower inflation
Our base case is we believe inflation will be contained over the medium-term although the possibility of higher inflation is greater than it has been for several years as factors like globalisation and demographics may become less influential in keeping inflation low.
Despite renewed national lockdowns, the global economic recovery does not appear to have been blown off course. There were signs that the rollout of national vaccination programmes had begun to raise optimism among businesses and consumers, providing a boost to underlying economic activity.
However, the slow pace of vaccinations in Europe generated concern of a slower path back to normality for some.
Quarterly Performance Overview
The Risk Managed Portfolios hold relatively little in US Treasuries or other mainstream government bonds but the sell-off did effect other assets that they hold, like corporate bonds. Most equity markets registered solid gains given the apparent brighter prospects for a global recovery, so this was beneficial to performance in the first quarter.
|LF Prudential Risk Managed Active 1 P Acc in GB||-0.62||15.75|
|LF Prudential Risk Managed Passive 1 P Acc in GB||-2.91||14.22|
|LF Prudential Risk Managed Active 2 P Acc in GB||0.34||19.18|
|LF Prudential Risk Managed Passive 2 P Acc in GB||-1.82||16.87|
|LF Prudential Risk Managed Active 3 P Acc in GB||1.30||22.40|
|LF Prudential Risk Managed Passive 3 P Acc in GB||-1.08||20.52|
|LF Prudential Risk Managed Active 4 P Acc in GB||2.36||26.98|
|LF Prudential Risk Managed Passive 4 P Acc in GB||0.28||24.88|
|LF Prudential Risk Managed Active 5 P Acc in GB||4.53||31.20|
|LF Prudential Risk Managed Passive 5 P Acc in GB||1.36||29.39|
The chart shows the annualised performance of each fund in the LF Prudential Risk Managed Active and Passive range over 3 months and 1 year. Outperformance relative to the comparator benchmark for each fund is indicated by the green boxes.
Source and date – FE, total return bid-bid month end (31 March 2021) performance table from UK Investment Association universe.
So overall it was a mixed quarter with several of the lower risk funds producing negative returns but with the Risk Managed Active range outperforming. For example, Risk Managed Active 1 returned –0.62% compared to Risk Managed Passive 1 returning -2.91% and Risk Managed Active 5 returning 4.53% compared to 1.36% for Risk Managed Passive 5.
The key drivers of returns for the Risk Managed Active Portfolios in the first quarter was not only the regional equity allocations but also strong performance from the underlying active managers, several of whom benefitted from owning many stocks that markets feel will do much better now with economies re-opening. The UK, US and Asian equity holdings in the Risk Managed Active funds all had very good quarters, outperforming the equivalent vehicles in the Risk Managed Passive range, albeit after some challenging periods in recent years.
Another positive note for the Risk Managed Active funds during the first part of 2021 was property. Whilst the theme of re-opening economies has contributed to short-term challenges in bond markets, this has been good for commercial property such that all three holdings, the UK REIT and the L&G and M&G funds contributed to the strong relative quarter for the Risk Managed Active range.
Finally, in fixed income, the change in investor sentiment meant that most corporate bond funds across both portfolios produced negative returns apart from the M&G Global High Yield Fund which was the standout in the first quarter.
The underlying active corporate bond managers in the Risk Managed Active funds generally produced stronger returns than the equivalent iShares vehicles in the Risk Managed Passive range.
Activity within portfolios
The active China equity mandate run by Value Partners was onboarded in the Risk Managed Passive range having already been added to the Risk Managed Active range in Q4 2020.
Portfolio positioning has remained largely unchanged so far in 2021 with small overweight positions held across all the main equity markets. The portfolio manager remains focused on the increased volatility in, and level of government bond yields. The potential for them to increase in an environment of higher growth and accommodative central banks is being monitored closely.
The portfolio manager believes a continued gradual increase in yields driven by an improving economic picture will likely be digested by equity markets that have viewed the increased US fiscal spending favourably.
However, more volatility and increased uncertainty about the stability of yields may dent sentiment once again. The portfolio management team see this as a key risk to markets in 2021.
The value of any investment can go down as well as up so your customer might not get back the amount they put in.