The 2019 Strategic Asset Allocation (SAA) review concluded that a reduction in the expected risk profile of the funds was appropriate given the prevailing economic and capital market conditions. This reduction was driven by the stage of the economic cycle and vulnerability to exogenous shocks, on the basis that we might be presented with better opportunities in the medium- term.
At the beginning of 2020, we saw a marked increase in volatility and repricing of risk assets due to the pandemic. Whilst we remain cautious on how developments may unfold, the medium-term picture and substantial easing programmes from central banks and governments continues to give us sufficient confidence to increase risk. This is consistent with recent changes implemented across the Prufunds range. Liquidity issues have eased, and loosening of lockdown measures is feeding through to economic activity.
Increase in equity exposure and reduction to fixed interest, consistent across the different risk-rated funds.
Introduction of new asset classes: Chinese equities, South African equities, and Emerging Market Debt. We have a preference for active management in these areas for both the Active & Passive ranges.
Re-allocation of regionalexposures due to structural long-term dynamics and valuation opportunities.
Property & Alternatives – No Change
New Asset Classes (Active & Passive)
Chinese equities – Initially passive exposure via Futures. Active management will be introduced later this year.
Reflects China’s importance to the global economy and the gradual maturity and opening of Chinese capital markets. China’s share of global GDP is not reflected in share of global market capitalisation (16% v 11%, Source: IMF, 2019), and market indices have recognised that they are underweight. This is accompanied by a maturing market infrastructure and structural reforms, factors which are supportive to Chinese equities in the long-term. Additional potential diversification benefits lie in the de-synchronisation of monetary policy versus the rest of the world, and we expect growth to be higher than the US over the next 10 years.
South African equities – Same exposure as the WP fund/Prufunds, actively managed by Prudential Investment Managers South Africa (PIMSA).
Overall, there are a number of favourable structural characteristics which have the potential to generate robust long-term economic growth and create positive spill-overs for asset markets. These structural factors include the continent’s favourable demographic profile and the prospect of an emerging middle class. In addition, the projected rapid urbanisation and infrastructure development should generate considerable productivity gains. There has also been progress in improving the region’s institutional quality, encouraging political stability and promoting the business sector; however, this area remains a key vulnerability and continued progress is required to achieve the continent’s long-term potential.
Emerging Markets Debt – M&G Emerging Market Debt Fund
Specific allocation to include a mixture of local & hard currency, government and corporate debt, providing opportunities for further diversification. Emerging markets have idiosyncratic risks which are better suited to active management through a well-diversified portfolio.
We have been assessing the market actions relative to their economic impact, whilst also understanding the vulnerabilities in different economies and regions. Some regions are structurally more vulnerable than others, and we would seek to allocate away from these regions. On the other hand, some regions may have been adversely impacted despite their better structural long-term dynamics, domestic demand and the intrinsic benefits of the lower oil prices. Finally, we have also taken into account the likely short-term versus long-term economic impact of Covid-19 and the subsequent monetary and ensuing fiscal policy responses.
In terms of the split between domestic vs. overseas equities, we have diversified our equity portfolio over the past few years to a stable allocation to overseas equities. The introduction of Chinese and South African equities provides further diversification and builds on the theme of a continued shift in the economic centre of gravity towards the east (driven by demographics and globalisation).
UK Equities - We currently see a meaningful differentiation in medium-term valuation and have increased the allocation accordingly.
The UK economy is at crossroads in terms of future outcomes, with growth prospects greatly dependent on the future trade relationships with the EU. However, this is partially mitigated by the global nature of corporate profits. From a valuation perspective, the gap between the forward earnings yield on UK equities and its developed market peers is at extreme levels relative to history. This is particularly noticeable in regards to European equities, where the premium is close to the largest it has been for 20 years.
The past year has seen a reversal of premature monetary policy normalisation, prompting strong declines in government bond yields to all-time lows for developed markets. Monetary policy now has less room to stimulate and, whilst yields can potentially go lower, absolute return potential from developed market Fixed Income is less appealing.
UK Fixed Income suffers from political and trade deal uncertainty. Long-term growth and inflation prospects are very much dependent on the future trade relationship with the EU, and yields look less attractive. European Fixed Income suffers from very low yields, whilst US Fixed Income yields have compressed significantly since the turn of the year, and hence a rotation into higher yielding assets is merited at this stage:
Emerging Market Debt – Provides higher yields and exposure to a diversified set of monetary and fiscal regimes, with more room for monetary stimulus.
Asian Fixed Income (Risk Managed Active) – Meaningful increase in allocation to Eastspring Asian Bond Funds (Local & Hard currency). Asian Fixed Income remains well positioned to benefit from the broadening and deepening of the market, structural reforms, and the growth of a strong domestic investor base. Economies at different stages of the monetary cycle helps to create opportunities for active managers, and provides diversification benefits.