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Humans learn more from our mistakes than our victories. So it’s important to evaluate decisions we have made and, more importantly, to look at the events surrounding our decisions. We don’t view our investment process as a secret to be kept from our clients. On the contrary, it’s your money and it’s important we’re transparent about how we’re managing it. So, that’s what our first quarterly outlook of the year seeks to achieve: to look back at 2019’s headwinds and tailwinds, explain how we applied our investment process to deal with them, then provide our thoughts on how markets will develop over the next three months.
As you’ll read in the Update on Model Portfolios section on page 15, 2019 was a strong year for Dolfin discretionary clients from a performance perspective across the primary currencies and the different risk profiles. It was a year of two halves though – with a majority of equity gains coming in the first few months of the year. Since then, our focus has been on protecting the downside and minimising unnecessary volatility for our clients. We built up some of the satellite holdings that sit within our thematic ideas.
We are leaning towards a stock market sell off
One of our struggles in the second half of 2019 was the increasingly stretched valuations that made it harder and harder to justify global beta equity exposure. The S&P500 finished the year with a P/E ratio of 23. There are only two ways for this to be normalised: either a stock market sell off or an incredibly strong earnings season. We are leaning towards the former in the first quarter of 2020 so remain positioned defensively to protect our clients’ assets – but would quickly re-deploy into global equities post this sell off. One of the issues with evaluating this decision, which saw our clients missing out on some upside, is that it forces an investment manager to determine what their investment strategy is. Are you happy being one of the herd, chasing markets higher as valuations become more and more stretched and hoping that you exit your position before the snapback? From our perspective, we remain focused on absolute returns because this is what our clients demand. From a performance perspective that means we missed out on some of this upside, but we still managed to outperform our absolute benchmarks and, from what we can tell, our peer group, with lower volatility.
One of the most frequently asked questions from clients in recent months was ‘are we going to have a recession next year?’ Despite our equity positioning, which is more about valuations than fears overrecession, our answer is ‘no’.
The US Federal Reserve has cut rates having been backed into a corner by President Trump. Indirectly, this has prevented the US dollar from strengthening further, but in combination with low unemployment, lower debt costs and low inflation has provided a very supportive environment for the US consumer. US consumption growth has lagged income growth over the last ten years with the consumer upping its savings ratio over the last 10 years from 5 to 8 per cent. This has led to a doubling of household net worth over that period. We don’t believe that the Fed will cut interest rates any further, but as we are now in another US election year, they essentially become hamstrung. We will be closely watching Core PCE data over the course of the year – one of our scenarios involves a weaker US dollar importing higher inflation into the US and the Fed unable to act until post-election – and the subsequent reactive rate adjustments being too heavy and pushing the US into recession as we head into 2021.
The UK looks poised to push through the EU withdrawal agreement later this month and the Prime Minister has laid out a definite agenda on both timing but also spending plans. In our Fixed Income section on page 35, Geoff Wan looks at whether this will have much impact on gilt yields and whether there is a subsequent impact on borrowing costs for UK companies.
We have concerns about debt issuance to fund company dividend and share buyback programmes. This has been a big driver of recent stock market performance, as Mikhail Trebunskikh explains in detail in the Equities section on page 53.
Across our client base we have also seen rising interest levels in impact investing. As part of our Alternative Investment section on page 91, Anny Giavelli looks at how the industry is developing. Dolfin is evaluating a lot of direct venture capital investment opportunities and we increasingly see that these have some sort of a positive impact output. However, the definition of what exactly counts as an impact investment and, more importantly, how do you measure the output, is something that many institutions are still struggling to define and wrap their head around. Impact investing is something that we are increasingly spending more time on, not least as part of our Private Investment Club in which we offer clients the opportunity to co-invest alongside each other into some very interesting impact opportunities.
Across our client base, we have seen rising interest
in impact investing
A traditional list of human ‘basic needs’ for survival in its simplest form is food, water and shelter. In the previous two quarters we explored the future of food and water usage. From page 99, we turn our attentions to shelter and consider the impact and future of housing, taking a look at the investment opportunities that might arise as a result of technology, urbanisation and social care.
I believe that 2020 will be a year of two distinct halves and patience will be rewarded. After a decade of strong public market returns, now is not the time to be greedy. Strong absolute real returns are generated by managing risk appropriately, not overextending a portfolio and avoiding the downsides.
We hope to see many of you at one of our upcoming events this year. We will be hosting our first quarterly investment outlook event in April 2020 at which we’ll share some of our updated investment ideas, report on model portfolio performance, and delve into the impact investment space in more detail.