How do we invest if the music stops in 2022? Darius McDermott, managing director, FundCalibre, looks at what might lie ahead
I never thought resiliency and uncertainty could go so hand in hand, but both seem to have been the story of 2021 from an investment perspective.
On the one side, markets continue to climb ever higher. Year-to-date global equities have returned over 20 per cent, despite huge uncertainties surrounding the likes of the pandemic, Brexit fallout and Chinese regulation*. In fact, every major global market has recorded positive returns thus far*, with Europe and the UK a particular surprise.
But with all markets (bonds, equities and many alternatives) now expensive, and central banks starting to withdraw their stimulus, uncertainty remains as prominent as ever. We know from history that when markets are expensive it takes very little to unnerve them.
I recently saw an article which described financial markets being a bit like the final orders at a stag-do! We’ve all had a great time following the sell-off, but there is an awful mess that still needs to be cleaned up when the music has stopped.
Bonds are a perfect example. Following the huge opportunities seen in 2020, they have now gone back to pre-pandemic levels, with yields at historic lows. Simply put, no one can expect the unprecedented amounts of fiscal and monetary stimulus in places like the US to not have an impact on yields at some point.
We’ve had something of an economic imbalance courtesy of the past decade of free money. It does feel like the strong recovery we’ve seen, coupled with inflationary concerns, has created a tipping point.
A recent market update from Bank of America says investors should prepare for a more challenging 12 months ahead – adding that “we are on the cusp of a policy pivot from pro-growth to anti-inflation”**.
I agree with most commentators that the market looks set for some type of correction in 2022. We can’t ignore the strong gains in the past 20 months or so in what has been the most artificial of markets, courtesy of central banks. A large part of next year will be about capital protection, whilst eking out some returns above inflation, and there are a few areas which can help with both.
Investing for income
Income is always a priority – but it could become an even greater challenge in an inflationary world. I think the UK could become an attractive option again in the next 12 months. UK equity income investors faced a double whammy in 2020, as not only did dividends paid to investors fall 44 per cent on a headline basis***, but the average fund in the sector saw its assets fall more than 10 per cent****. However, this year has seen a revival of sorts, with the latest figures showing dividends recovering nearly 90 per cent year-on-year in the third quarter of 2021.
We know about Brexit and the vaccine bounce, but rising M&A activity also indicates the UK is being perceived to be undervalued versus its peers. I would look to the multi-cap space for a diverse range of UK-dividend payers, with the likes of LF Gresham House UK Multi-Cap Income and Marlborough Multi Cap Income coming to mind.
Another maligned sector which could offer safety and some growth is absolute return funds. Their purpose is to manage the cycle for investors and to smooth returns as the cycle progresses, outperforming in a bear market, although they will often underperform in a bull market. They tend to have high flexibility and make the most use of diversification, avoiding pure directional market plays to achieve a low correlation to the broader markets.
With a growing expectation that traditional funds will struggle as monetary policy is tightened – and inflation potentially rises – I’d consider a diverse offering like the SVS Church House Tenax Absolute Return Strategies fund, while a total return offering in the fixed income space, like TwentyFour Absolute Return Credit fund, is also worth considering.
The final area really does underline the uncertainty in markets. We saw value investing show great signs of recovery in the early part of this year, before growth investing once again took over in markets. The question of whether inflation is transitory or not looms large over which market style is likely to lead the way from this point. So, I’d also look to incorporate a few managers who truly operate a style-agnostic, pure stockpicking approach to markets. For this I’d consider the likes of Janus Henderson European Selected Opportunities and Fidelity Global Special Situations. The funds are managed John Bennett and Jeremy Podger respectively, both of whom have excellent long-term track record across different market conditions.
I’d just like to finish off by wishing everyone a Merry Christmas and a Happy New Year.
*Source: FE fundinfo, total returns in sterling, 30 December 2020 to 2 November 2021
**Source: BusinessInsider.com
***Source: Investment Association
****Source: Link Group – Global Dividend Monitor – Q4 2020
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
