In the latest Investment Q&A, the Fund Calibre team talk to Simon Nichols, manager of Elite Rated BNY Mellon Multi-Asset Balanced, who explains why he believes the world’s leading technology firms can continue to deliver strong performance heading into 2024.
As well as discussing the fund’s thematic approach, he also highlights his preference for government bonds and explains how uncertainties surrounding interest rates, economic growth, and inflation impact his economic outlook going into 2024 – and where he believes there will be opportunities next year.
Why you should listen to the interview: Simon introduces the fund well, breaking down its core themes, explaining how they interpret real world ‘future’ investment themes. He additionally gives an interesting perspective on how bonds and equities are set to co-exist in a more correlated space and how that works for his portfolio.
Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, tune in to the ‘Investing on the go’ podcast.
What we found interesting:
Are bonds and equities now in lockstep?
“It is never one scenario or another but 60/40 portfolios have moved in lockstep over recent years. There are clearly factors which may drive bond returns to move in the same direction as equity returns over some periods, but there are also other factors which may drive them in the opposite direction. And so I guess it depends on what the market is most focused on and wants to emphasise at any particular point in time.
“Thinking about how these drivers work, the risk-free rate is effectively the building block for the valuation of any financial asset. And this really is determined by the rate that is available on US treasuries as these are often used as a proxy by investors for the risk-free rate. Now, if we look back over the last number of years, these rates have been held artificially low due to the quantitative easing and monetary policy that has been in place by central banks around the world. And these central banks were buying bonds for reasons other than the investment return that they offered. And so, I think in an environment where policy action is driving the key buyer or seller in the bond market, then maybe you’re in a situation where bond and equity returns maybe move together with each other because you’re changing effectively the cost of capital.
“In my view, we’re now in an era where the risk-free rate is more determined by market participants other than central banks and policy makers, so real world market participants. Over the last couple of years we’ve seen that bond markets have had to adjust to the lack of return-insensitive buyers and we’ve seen yield move higher, particularly real yields becoming positive once again. And so, I think bonds can now play a more diversifying role in a multi-asset portfolio than perhaps they have been able to over the last few years. And clearly where that moves, it will depend on your view on inflation, it will depend on your view on whether there’ll be a hard or soft landing for the economic outlook. But I think in this kind of environment then bonds and equities might potentially move in different directions to each other going forward.”
Future-facing growth drivers
“So the fund does have exposure to larger companies in the market. And really, we’re looking for companies maybe in the technology space, in the industrial space, that have got the ability to invest behind these longer-term themes that we’re thinking about. But we’re not style-biased, we’re not looking particularly for growth companies or for value companies.
“We do like companies that have strong capital allocation and if management teams have got fantastic growth opportunities to invest behind at high returns on capital, that’s great. We would encourage them to go and invest the capital that a company is generating behind those opportunities.
“The fund does invest behind some of these more longer-term thematic growth drivers. Technology industrials are the examples we’ve used, but we also hold companies that perhaps have lower growth outlooks and higher dividend yields. And so, when we are thinking about where we’re going to achieve a return from these investments – perhaps more of our return will be coming from the dividend yield and the return of capital than it would from the growth opportunities – but what’s very important when we’re looking at companies with lower growth outlooks is that their products remain relevant to the future. Maybe an example of this might be in the packaging sector, we will invest behind packaging manufacturers. You know, most of my delivery is still come in cardboard boxes. And so we think that those products are future-facing.”
Big tech can continue to perform reasonably well
“The Magnificent Seven, those large technological stocks in the US market, have really driven most of the returns this year from US equity markets. I do actually think that big tech can continue to perform reasonably well. I don’t tend to look at things in terms of larger caps versus small caps. I’m a great believer in, it’s the earnings growth and the cashflow growth that a company can produce that really matters in the long term.
“So, if we think about Nvidia, which is obviously really at the vanguard of artificial intelligence, so they are designing the computer chips that are making artificial intelligence programs possible. The stock is up, I don’t know, maybe more than 250% this year. But when we look at the earnings, if we were to look at the start of this year and look at the earnings that the market was expecting in 2025, those earnings expectations have actually moved more than the share price. And so Nvidia is on a lower P/E rating now (depending on where the share price is at time of publishing) but it’s on a lower rating now than it was at the start of the year. And so, that appreciation we’ve seen in the share price has really been driven by a significant change in the future earnings outlook of that company.
“Now, that’s not the case for the whole of the Magnificent Seven. Some have achieved the growth we’ve seen in the share price due to an element of re-rating as well. But I think that’s because those companies are very well positioned to take advantage of the new technological wave that we’re seeing. And so artificial intelligence may improve their products that they may well be able to charge a little bit more for in the future. And so their future earnings outlook has improved a little bit.
“I accept that those companies have really driven the market. And it has been an element of re-rating this year, but over the long term, those companies that have got the best earnings growth, the best cashflow growth, whether they are small or large, are likely to perform particularly well.”
‘Stock-pocalypse’ – or opportunity?
“Obviously we’re always looking for opportunities. We’re investing on a longer term timeframe rather than what’s going to happen in the next quarter. Having said that, our equity weighting is towards the lower end of where we’ve been historically — we’re in the low seventies at the moment. Our cash weightings are a little bit higher than we’ve seen over the recent past, but then we’re achieving a reasonable return on cash now, given where base rates are. I think we are in this period where we’re seeing another shift in the interest rate regime. And so, all investors are wondering whether interest rates have peaked and how fast they will come down and whether the interest rates that have been put in the past will operate with a lag and therefore will reduce economic growth, maybe causing a slight recession or maybe just slowing down activity in the market to allow inflation to come down more in-line with what central banks are thinking.
“So, there is quite a lot of uncertainty at the moment. We have been through a very, very steep interest rate rising period over the last 12 to 18 months, so we are marginally cautious in terms of is some of that yet to feed through into corporate earnings, which is why we’re a little bit lower in our equity weight. But we definitely see areas of opportunity over the longer term with some of the fantastic growth opportunities that our thematics are pointing us towards.”
Conclusion
If anyone has been writing the obituary for 60/40 portfolios, think again. Simon demonstrates how and why he prefers investing in larger companies; his focus on “future-facing business models” which are capable of harnessing megatrends within their industries, is clearly demonstrated through the themes his fund carries. He also demonstrates how he utilises opportunities in the fixed income market alongside equities to great effect.
