M&G Treasury & Investment Office Q1 2019 Investment Update
This update aims to provide an insight into the performance of markets and how this has affected underlying PruFund portfolios.
In a complete turnaround from Q4 2018 many assets have performed well so far this year despite the backdrop of weaker data, with many equity indices producing double digit returns to the end of March. We believe there are two key drivers of the more positive sentiment in the first quarter.
Firstly, the US Fed has stepped back from its rate hiking cycle and is now seen as on 'pause'. Following the March committee meeting their median forecasts now point to no rate hikes in 2019. Growth and inflation expectations have also been lowered slightly. Weakening economic data is reinforcing expectations of a potential rate cut which in turn is providing a short-term boost for equities. There was some good news, the US trade deficit narrowed in February and home sales increased due to revised interest rate expectations.
Much is said about the US yield curve and weak manufacturing data in the US and Europe at the end of the quarter caused another inversion (3-month v 10 year) creating more debate around the risk of recession. Whilst not directly related we thought these comments from the Chicago Fed were interesting; 'We have to take in to account that there's been a secular decline in long-term interest rates' and 'it's probably more natural that yield curves are somewhat flatter than they have been historically'.
Secondly, trade talks between the US and China look to be moving towards a resolution and markets are hoping for a positive result over coming weeks. At the end of February President Trump announced a delay in the increase of tariffs due on 1st March, citing progress in the negotiations. Robert Lightzer, the US trade representative told the House of Representatives that a process for enforcing trade agreements between the two countries has been decided. It is quite possible that this recent optimism has led many investors to shrug off weaker data on US inflation and disappointing numbers from the Chicago PMI which is an important barometer of the US economy.
In the UK the Bank of England MPC also met and as expected left interest rates unchanged with the minutes noting the effect of Brexit on confidence, short-term investment and general levels of activity. Without this there would arguably be a case for tightening as evidenced by stronger retail data in March, strong PMIs and unemployment unexpectedly falling to 3.9%. There was some good news in Europe as business morale has shown signs of improvement even as PMI numbers continue to fall.
The macro economic data that we analyse still suggests that the global economy will grow in 2019 although at a slower rate than 2018. Inflation appears to be contained and central bank policy is supportive. This is an environment that we believe is supportive for assets like equities and property.
Near-term risks remain, and these include; any deterioration in US/China trade negotiations or a significant downturn in macro data, like PMIs. It is also possible that investor sentiment could be dented if macro data was much more positive than expected as this would increase rate hike expectations.
Portfolio activity and tactical asset allocation positions
Market returns to date in 2019 have certainly been beneficial to the globally diversified portfolios underlying PruFunds and where possible the portfolio manager has allowed positions to drift, within strict operational limits, to harvest some of these returns.
From a tactical asset allocation (TAA) perspective, we wrote last summer about the mandate that has been created which is run by Dave Fishwick, head of the Macro Investment Business (MIB) within M&G Investments. The process employed is sophisticated and has been in place for many years but in short, he will most likely take a ‘long’ position in an asset or sector where he sees value that has not yet been fully derived or a 'short' position where he believes an asset or sector offers less value.
To summarise some of the positions currently held within the TAA mandate;
- Long – US banks, European equities, US treasuries, Asian equities, Japanese equities, Emerging Market debt
- Short – Long Dated Gilts, German Bunds
Primary Wave Fund II
The alternatives team within T&IO have invested in this fund through Primary Wave, one of the largest independent music publishing, marketing and talent management firms in the US. This new fund focuses on investing in long-dated music royalty streams, often involving legacy artists. The structure of the music industry today is such that legacy artist cashflows can be more secure and modelled over several years while businesses like Primary Wave will also look to enhance an artists’ brand and generate more opportunities and revenue. Before creating this second fund they had previously closed deals with the estates/representatives of Kurt Cobain, Steven Tyler, Smokey Robinson, Steve Cropper and Bob Marley.
The theme of music royalties is something that the team have been following for some time. Aside from being a very sound investment
It has been an extremely eventful last few months in markets but has served as a reminder that genuine long-term investing and global diversification can often shield investors from the worst effects of volatility. The returns generated by the Prudential With-Profits Fund in 2018 are a testament to this. The smoothing process employed across the PruFund range is another important weapon in the Prudential armoury.
Whilst volatility in markets can be worrying for advisers and their clients, it's always likely to present opportunities for long-term investors to acquire good quality assets at lower prices and any portfolio that can hold private assets across property, credit and alternatives will often produce competitive relative returns in challenging market conditions.
As always Prudential believes that patience, a long-term view, global diversification, private assets and the ability to source niche investment opportunities will allow portfolios to benefit whilst potentially providing a buffer against market downturns.
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