Watch previous quarterly updates about our Managed Portfolio Service (MPS)

Q3 FY2023-24

Video transcript
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    Hello, good day and welcome. My name is Simon Taylor, Head of Strategic Partnerships at Investec Wealth and Investment. And it's my pleasure to be your host and to welcome you to this quarter's market update and review of the Manage Portfolio Service.

    I'm joined today by Ronelle Hutchinson, Senior Investment Director from our Investment and Research Office, and Andrea Yung, the Investment Director focused on our Managed Portfolio Service. Good day to you both.

    For the next 30 minutes, we will consider investment markets, looking back over a very eventful quarter, which saw interest rates and inflation remaining high and markets continuing to be volatile. We will also look ahead to 2024 and beyond, considering what the investment outlook means for the MPS Portfolios, your clients and your firms.

    Now, before I start, I'd like to draw your attention to some exciting corporate news. Our combination with Rathbones, the leading provider of individual wealth management and asset management services to individual clients, charities, trustees and professional partners completed on the 21st of September. Our combined business now manages in excess of £100 billion of assets on behalf of clients and partners. And together we now have over 675 investment managers working out of 23 offices throughout the UK and Channel Islands.

    In the coming months and weeks ahead, we will bring you more information on how this amazing combination is benefiting you and your clients. In the meantime, rest assured that your clients and your business are partnering with the largest discretionary fund manager in the UK and one which can truly boast a local presence. If you'd like to hear more about this, please do reach out to your local Business Development Manager, or drop me a line after this video.

    Today's quarterly update is accompanied by a very useful guide for advisers to use with clients on the value of staying invested. And this covers why investment returns have been difficult to come by of late, why time in the market does matters when it comes to long term investing, why it's important to stay invested, and where we see value and opportunities. If you'd like a copy of this guide, please do contact your local Business Development Manager or indeed, drop me a line.

    The third quarter has been a challenging backdrop for global equities. Interest rates have remained high, bond yields have remained elevated and global growth has struggled as a result. To talk more about this, I'm delighted to invite Ronelle Hutchinson, Senior Investment Director, to the microphone.

    Thanks Simon. So, looking to the global macro environment, if we just look at the performance of asset class returns in the third quarter, as SImon pointed out, you know, the strong start to risk assets in the first half of 2023 faltered in the third quarter as global equities delivered negative returns.

    If you look at the S&P 500, it delivered negative returns in dollars, but in pounds, managed to be up 0.8% as the pound weakened against the dollar. Looking at UK equities, they were up 2.4%, delivering out-performance relative to US equities. And generally global bonds struggled as the rise in yields negatively impacted the bond market. A notable outperformer was commodities, with the gain in oil prices as a result of production cuts in Saudi Arabia and Russia.

    When you look at the year-to-date performance of asset class returns, it's been a positive screen across the board. As you can see, global equities have surprised on the upside, largely as a result of the resilience we've seen in the global economy.

    If you look at the S&P 500, it is up 11%, driven by that strong rebound in the technology sector as a result of ChatGPT and generative AI. Moving to Europe, it was up 7% and the UK has delivered a positive return of 5%. Generally, when you look at bonds over the period, they have struggled. But there have been areas of positivity, specifically in the UK bond market. But really marginal gains.

    If you look across to currencies, the pound is stronger on a year-to-date basis, up 1.5%, despite the weakness that we experienced in the third quarter. Just looking at what really drove risk assets over the quarter, as Simon shows here, once again you had volatility in the interest rate environment, largely as a result of the strong labour market data, as well as higher oil prices, that kept central banks hawkish over the period.

    And as a result, investors across the board had to reprice the interest rate outlook for the remainder of the year, forcing them to reprice interest rates higher. And this dented sentiment across the board.

    Just moving to the next slide, what we can see is that despite the economic resilience we've seen this year, the continued much higher for interest rates is likely to take its toll on the global economy. And as you can see, the recent update from the IMF has pointed to downgrades for economic growth.  For 2024, they've downgraded it by 0.1% to 2.9% and that's well below the long-term historical average.

    So we do feel that these higher rate are likely to take its toll and we're really seeing it already in the Global Purchasing Manager Index, which has now deteriorated and is showing, signs of slowing in the economic momentum and no more is this evident than in the next slide, which shows the UK Purchasing Manager's Index for both the manufacturing and service sectors. And as you can see, while the service sector has been quite robust for the large part of 2022 and the early part of 2023, the reality is that the cost-of-living crisis is now denting the post-Covid resilience that we've seen in the service sector. And as a result, the weakness of the UK economy is now evident and recession risks remain. So it's still definitely a risk there.

    If we just move to the next slide, the combination of a weaker economy and falling inflation has given the Bank of England reason to pause interest rates, which they have just done at the latest Central Bank meeting. They have opted to pause the hiking cycle at these current levels. And if you look at the chart on the right, which is showing pricing in these changes in interest rate expectations, if you look at the orange line at the very top, that was the July expectation of interest rates. Post the BOE pause in September, you've seen interest rate expectations decline by the second orange line at the bottom there. And clearly what it means is that bad news on the economic front is turning out to be good news for the interest rate outlook in the months ahead.

    If we just move to the next slide, the reality now is that the sharp rise in interest rates has actually been quite positive for savers and current investors at the moment, because you're getting very attractive yields on cash at the moment. And this is well beyond the subpar returns we've seen over the last decade. So cash and fixed income assets are now offering very attractive alternatives to equities, and so investors are now losing that incentive to own equities - not just in the US, but the UK as well as the rest of the world - because of this rise in interest rates and the attractiveness of fixed income.

    Just turning to the next slide, it then leads us to reflect our current assets allocation view, which is to remain underweight equities and US equities, specifically. If you look at the chart on your left, which is showing the valuation levels of US equities at the moment currently sitting at 18 times PE. Well above the long-term average of the 15 times average.

    While in the short term, we don't know what the outlook for equities is going to be longer term, we know that from these elevated levels of valuation in US equities markets, combined with tighter financial conditions and already a downward trend in corporate profitability in the US, definitely we see that over the long term, the outlook for US equities is less positive. And hence, we are underweight at this particular stage.

    But there is some good news. As I alluded to earlier on, fixed income assets, are becoming more and more attractive. And if you look at the next slide, what you can see on the chart on your left is the range in the grey bar there, the blue shaded range, is showing the range of yields across maturities over the last 15 years, and as you can see that blue line at the very top shows the current yields of fixed income assets across maturities.

    And as you can see, they are showing the most attractive yields over the last 15 years. And then if you move to the chart on your right, this is a very interesting chart. It's showing the impact of a 1% rise or fall in interest rates and the impact that this will have on fixed income assets. And as you can see, there is a positive skew across all maturities.  A rise or fall in interest rates is actually showing that there's a positive skew, and there’s more upside to be gained from fixed interest, irrespective of where interest rates move from here.

    Obviously, the longer dated, like the 30 year US Treasury will be negatively impacted. But what we're seeing is an asymmetric return profile for fixed income. And as a result, we've moved more positive on the asset class, from an asset allocation perspective. And with that, I'm going to hand back to Simon.

    Thank you Ronelle for that update on the global macro picture. And I think the sort of main points that I took away from that were that, with this sort of weaker economic picture on growth and falling inflation, we think we're close to the peak on interest rates and there's clearly, at current yields, with the risk return skewed in favour of fixed income, that's clearly a positive for those holding fixed income assets. And that's one of the things that we continue to look at quite strongly.

    And I think you also mentioned there that when interest rates do moderate, equity portfolios should rise as the equity discount rate improves. So some positive news on that point. Now, let's look at the MPS Portfolios themselves in a little bit more detail. I think this has been a busy quarter for the MPS Portfolio management team, as they look to reposition portfolios for the future. So to talk through the managed portfolios that we have, and the changes that we've made over the quarter, I'm delighted to invite Andrea Yung to the microphone.

    Andrea is the Investment Director who's focused on our MPS range. And as a quick reminder, we have six portfolios across the risk return spectrum. Those portfolios are continually being rebalanced to ensure that they stay within their risk return pathways. And that rebalancing process in itself has the advantage of making sure that we're continually cashing in on gains and capitalising on valuation opportunities with underperforming assets. Andrea, I see that we have made some changes to the portfolio this quarter, which have had a positive impact on total expense ratios and TAAS (tactical asset allocation) changes. Perhaps you could talk the audience through these?  Andrea over to you.

    Thank you Simon. So I'll cover the main changes that we've made to the models since our last update, why I think we're well positioned given the current outlook, and then I'll reflect on recent performance.

    So, firstly, here's a current breakdown of our asset allocation across all models. The main key points to highlight, and what I'll go into in a bit more detail on the following slides, is that we've slightly dialled down our alternative exposure and added to fixed income. And we've also diversified our equity exposure by reducing that UK home bias and increasing overseas exposure.

    So here you can see how the asset allocations have changed for each strategy in our core range over the quarter. Firstly, the reason why we've reduced our alternative exposure and increased fixed income, is due to the value that we're finding in that fixed income asset space, especially in the government bond space.

    Real yields over the quarter have risen. And as we're seeing as we're seeing, that peak US interest rates being pushed out further and that shallower decline being priced in. We're seeing this as an opportunity to benefit from the higher yields that bonds are offering.

    Now we continue to believe that there will be a slowdown in global growth, as Ronelle mentioned, and therefore the latest increase in yield we feel just provides us with that opportune time to also slightly increase our duration within fixed income to a more neutral stance.

    So, using the balance model as an example, this chart here shows how our asset allocation has changed over the quarter and how we're currently positioned. What this highlights is how we've increased our overseas equity exposure and adopted a more global approach. And our UK equity exposure, as a percentage of the overall portfolio, has reduced from 25.8% down to 12%, while our overseas exposure has increased from 31.8% to 45.5%.

    So looking at how this overseas allocation has changed, what you can see, is that we've increased our exposure across the regions, Europe, US, the Far East and emerging markets and general global Funds. And the reason why we've done this just stems from broadening our opportunity set, which we expect will lead to stronger returns over the long term.

    So the UK market is dominated by sectors such as oil and gas, mining and banks, and these are typically capital intensive and cyclical. So these types of sectors benefit from an interest rate rising environment when commodity prices are rising. However, looking ahead, the UK could begin to lag once interest rates expectations soften and the global market just opens up exposure to sectors that aren't available in the UK to global leaders with areas such as technology, manufacturing and healthcare. And I think this chart highlights it well.

    In equities, no country has a monopoly on industry leaders. So thanks to the size of its capital market, the US has many, particularly in technology and Europe and the UK compete in pharmaceuticals, staples and industrials. Emerging markets are increasingly producing future leaders as well. These areas are less thoroughly analysed, less efficient, and therefore offer a greater opportunity for upper generation. And by keeping our investable universe as wide as possible, we just give ourselves the best opportunity to generate superior returns and also to diversify that risk.

    So just having a look at the model changes in a bit more detail, here are the changes that we've made. So firstly, looking at fixed interest, we've increased our waiting in sovereign debt through the L&G All Stock Guilt Index, and we feel the risk adjusted return characteristics are looking favourable. As yields have increased, the return that you can get on the guilt is more attractive, and you've still got that potential for capital uplift as we approach the end of the hiking cycle.

    We've also increased opposition in the Royal London Sterling Credit Bond Fund by selling our position in the Fidelity Sustainable Money Builder. These funds both fall under the same UK investment grade sector and are quite similar in terms of structure and exposure. We've made this decision as we just feel that Royal London team have that edge at selecting bonds, especially in the less liquid area that offer a higher return. And we just believe that Royal London are market leaders within the space.

    Now within equities, we've reduced a number of our UK holdings in order to gain exposure overseas, maintaining only our most favoured names.

    So in the US, what you'll find is that we've dialled back our growth tilt and added exposure to more value focused names, just helping us to provide a more diversified exposure within the US, rather than adding concentration to those large cap growth stocks, which are on high valuations.

    The Beutel Goodman Value Fund is a good example of this. We feel that the fund managers have still demonstrated strong performance relative to the US market, despite not owning any of the large cap names, which is just evidence of their stock picking capability. And although our outlook on the market still remains cautious, we believe it pays to have this type of active management during this point in the cycle, as when we do see increased volatility, the fund manager will be able to be more flexible and responses and responsive to market inefficiencies and risk pricings compared to those passive funds.

    We've also adjusted our Japanese exposure by selling Bailey Gifford Japan, which is more growth focused to M&G Japan, which has a more blended approach with a bit of a slight value tilt. And we believe this fund is a compelling core value proposition for allocating to Japan and is best in class.

    We've also increased our weighting to Hermes Emerging Markets Equity Fund. And while we're aware of the impacts that the stronger dollar has had and the risks surrounding China, we see emerging markets as a longer-term beneficiary of an eventual weaker dollar and recovery.

    So just having a look at our fees, over the quarter, we've reduced both our underlying OCF and transactional fees, and this is mainly down to a few reasons. Firstly, gaining access to cheaper share classes has helped and we're continually working on this so we can get the best value for money.

    Secondly, we've increased our exposure to passives in the UK sovereign space, as we feel a passive gilt product provides the same exposure and similar performance for a much lower cost relative to other active gilt funds. And a reduction in alternatives has helped to reduce transactional charges, which are inherently higher than the other asset classes due to their hedge type structures in place.

    So this slide here just helps to visualise the cost reduction for each strategy, which hopefully is some positive news for your clients. And we understand the importance of total costs for clients, and we remain committed to reducing costs where we can without impacting returns.

    So the next slide here just shows the active versus passive split for each of our strategies. The passive weighting has increased mainly as a result of that fixed income guilt exposure that I mentioned. However, we still remain very much active, especially at this point in the market. If we do see market stress, our active funds can take advantage of these missed pricing opportunities. So just having a look at how our strategies have actually performed, this slide, shows how we performed over the quarter.

    And we have seen some slightly positive returns across our models. The dark blue line represents our strategies, and this is plotted against the comparable ARC indices for each of the models. And as you can see during this time, we've outperformed across most strategies, with the exception of defensive. And what's driven our performance this quarter has been the UK names.

    So thanks to energy and the basic material sector, which was supported by sterling weakness and a recovery in oil price, we've also seen domestic sectors improving on the back of positive consumer sentiment for the quarter. Also, fixed income showed signs of resilience within the corporate bond market.

    And our exposure to the Royal London Sterling Credit performed quite well. We've also seen a recovery in alternatives, most notably the JP Morgan Global Macro Opportunities Fund. This bounced back due to its hedge against the US tech sector and European equities, which were negative over the quarter.

    It has been property which has detracted from performance. And that's because of the global exposure in the Schroeder Global Cities Fund, which has generated negative returns. And that's been weighed down mainly by the US real estate section. So where we have seen slight underperformance relative to ARC has been in our defensive strategy, and this is mainly due to the high rating in property relative to that equity position.

    Now just looking year to date, we've seen mixed performance across our strategies, with defensive cautious and income lagging their respective ARC indices, while cautious plus balance and growth have either kept in line or outperformed.

    Now, the reason why our lower risk strategies have failed to keep pace with ARC is just due to our positioning on property and alternatives, which have struggled in the current economic environment. However, our outlook still remains cautious for global equities, and if we do experience periods of market weakness, it's these types of strategies which should help support portfolios.

    Looking within equities, we've been hurt by the lack of exposure overseas, most notably in the US and the magnificent seven, which have been a key driver of global equity returns year to date. Although we try to minimise sell backs when we look at value versus growth, our portfolios have historically had a bit of a growth tilt during the low interest rate environment, and these companies will usually create returns above the cost of capital. And this has served us well in recent years. However, as we've seen one of the most aggressive tightening cycles in history over the last 12 months, this has put downward pressure on the valuations of these types of companies.

    So this slide just details the timings of our tactical asset allocation decisions, as directed by our research team throughout 2021 and 2022, which we've reflected in our models. As evidenced, we have reduced risk through a reduction in equities during tough periods, and a lot of this reduction has been through the growth style equity funds. However, in hindsight, we could, and we should have been a bit more aggressive in this approach.

    Now, taking a longer-term view and looking at performance since inception, I'm pleased to say that we've still outperformed across all portfolios. We believe we can drive returns further over the long time over the long term, by adopting a more global approach and broadening that opportunity set.

    We also remain competent in our ability to protect portfolios on the downside and during market weakness. And with the support of our research capability, we're able to select the best ones in class. So with that, I will pass back to Simon.

    Excellent. Thank you Andrea. Thank you for that very comprehensive overview of what looks to be a very busy quarter for the MPS team. The three takeaways I took away from that were that we've clearly reduced alternatives in favour of fixed income over the quarter, we've adapted more of a global approach for equities, and I think, importantly for advisers and their clients, we have reduced the cost of portfolios throughout the quarter as well. So it's great to see that we are well positioned for the for the future.

    We've got a couple of slides here that we put into the pack just to help advisers with persuading clients of the merits of continuing to be invested in the market.

    But as I mentioned right at the very beginning, we've got a very handy guide, which we have just published for you. And I would advocate that you reach out to your local Business Development Manager and get a copy of that, for any conversations that you need to have with clients around continuing to remain invested in in these challenging times.

    With that, I think we move to Q&A.

    I think the first one I can see here is "You alluded to the magnificent seven". So for those advisors and investors out there that don't know who the magnificent seven are, or what the magnificent seven are, I thought it was a film, a Western film in fact!  Perhaps you can just enlighten us as to who the magnificent seven are?

    Yes, so when I refer to when we refer to the 'magnificent seven', these are the companies the likes of Amazon, Apple, NVIDIA and Meta. These are growth stocks within the US, which have done very well year to date. So our exposure to these has been through the L&G US index, as these actually make up such a large position of the benchmark.

    Brilliant. OK, so we have had exposure to those through the portfolios. Excellent. Lovely. Excellent. Wonderful.

    And Ronelle, I think there's a question for you here as well – "We clearly are predominantly still active within those portfolios. Obviously, markets are quite challenging at the moment in terms of the economic backdrop. Perhaps you could just give some comments and thoughts in terms of the importance of active management?"

    Thanks Simon. I think the current volatile environment suits definitely an active manager. Generally, what you find in broad systematic environments of geopolitical risk, rising economic uncertainty and deteriorating economic growth, headline indices across the board decline.

    Where we do have the benefit in terms of active managers, managers that are looking at companies with idiosyncratic risk factors, and drivers whose returns can often decouple from the economic environment. So being active in this environment makes sense where we will normally see quite a dispersion in returns and that really is the playing ground for active management.

    Thank you Ronelle. And one final question here, I think, relating to where the most assets are going into the 2plan managed portfolios at the moment. I think that's moderately cautious.

    But Andrea, probably you're better placed to answer that one. So we're seeing a lot of the traction and demand within the moderately cautious portfolio, which has done very well for us. And also within that cautious portfolio as well. That's where we're seeing a lot of the inflows coming in.

    Excellent, thank you. Well, there's no more questions from the audience. If any advisor out there watching do have further questions for us, please do, write them down and post them into us, and we'll be happy to provide answers to that.

    I think just before we finish off just a a few other things from the quarter.

    One of the latest platform studies has come in from Platform Forum, which continues to show that platform assets, into the managed portfolio service are growing. Very interesting that over the last 12 months, assets into platforms generally across the industry have actually declined from something like £680 billion under management to, something like £640 billion under management. So quite a significant fall. Largely, I suspect, due to asset prices and maybe, clients taking more out of portfolios on platforms than putting into portfolios on platforms.

    But one of the things that has stood up quite remarkably well over the quarter is the amount of money going in to managed portfolio strategies. At the at the beginning of last year, it was something like 12% of total assets on platforms. So around about £80 billion. It's now over 16%, over £100 billion.

    The latest report from Cerulli Associates, the respected independent research firm, predicts the number of financial advisors outsourcing investment decisions to discretionary fund managers will continue to increase as the regulator increases its focus on consumer protection.

    So for the any of those of you at the moment who haven't yet adopted the managed portfolio strategies, there’s plenty of material coming to you from our good selves in the near future.

    I also mentioned in terms of investing in current markets, a very useful guide that's been produced by John Wynn Evans from our Investment Research Office about helping customers to stay committed and invested in current markets.

    A very worthwhile read. Very supportive of long-term investing.

    And again, something, that you might find useful and your clients might find useful. So please do reach out to us.

    That's all for us for now.

    Thank you for your time, thank you for your support and we look forward to seeing you again at the next quarter.

  • Expand to read a summary transcript

    Over the quarter we have slightly dialled down our Alternative exposure and added to Fixed Income. Real yields over the quarter have risen and we are seeing this as an opportunity to benefit from the higher yields that bonds are offering.

    We have also diversified our equity exposure by reducing our UK home bias and increasing overseas exposure. By keeping our investable universe as wide as possible, we give ourselves the best opportunity to generate superior returns, and to diversify risk.

    Looking at fund changes over the quarter, we have increased our weighting in sovereign debt, through L&G All Stocks Gilt Index. We feel the risk-adjusted return characteristics are looking favourable.

    Within Equities, we have reduced our UK holdings to gain exposure overseas. In the US, we have dialled back our growth tilt and added exposure to value-focused funds. The Beutel Goodman US Value Fund is a good example of this. This is a value-focused fund with a quality overlay. The fund is not so geared towards the cyclicity of markets and should help to provide resilience during market weakness.

    In Japan, we have sold Baillie Gifford Japanese, which is more growth focused, and increased our weighting to M&G Japan which has a more blended approach.

    We have also increased our weighting to Hermes Emerging Markets Equity Fund. Whilst we are aware of the impacts that the stronger dollar has had, and the risks surrounding China, we see Emerging Markets as a longer-term beneficiary of an eventual weaker dollar and recovery.

    Over the quarter we have reduced both our Underlying OCF and transactional fees across all models. We have done this by gaining access to cheaper share classes and by increasing our exposure to passives funds in the UK sovereign space. Our reduction in Alternatives has helped to reduce transaction charges.

    Our portfolios remain active, with around 70% invested in active funds across each of our models. We believe this is important, especially as this point in the market cycle, where we are seeing a divergence of returns across different companies and sectors.

    Looking at performance over the quarter, we have outperformed across most of our strategies, with the exception of Defensive.

    What has driven our performance this quarter has been our UK names, thanks to the energy and basic materials sector which were supported by sterling weakness against the dollar and a recovery in oil prices.

    Fixed income showed signs of resilience with corporate bond markets outperforming. We also saw a recovery in Alternatives, most notably JPM Global Macro Opportunities fund.

    Taking a longer-term view and looking at performance since inception, we have still outperformed across all portfolios. We believe we can drive returns further over the long term by adopting a more global approach and broadening our opportunity set. 

Investec Wealth & Investment (UK) is a trading name of Investec Wealth & Investment Limited which is a subsidiary of Rathbones Group Plc. Investec Wealth & Investment Limited is authorised and regulated by the Financial Conduct Authority and is registered in England. Registered No. 2122340. Registered Office: 30 Gresham Street. London. EC2V 7QN.