End of the bull market prompts investors to appraise their equity strategies
With over a decade of strong markets and a bull run that seemed unstoppable, investors are assessing the changes brought about by post-lockdown economies, the return of the much-feared inflation and, subsequently, rates normalisation.
Low rates globally, booming tech stocks and the strong engine of growth in Asia have come to a halt. More importantly, the biggest adjustment for investors is to adapt to the rate of change in market conditions.
“Investors had become accustomed to a world where zero rates were the standard, inflation was not an issue, and Asia was a significant engine for global growth,” says Fella Khelifi-Arnulphy, head of UK advisory solutions at EFG Private Bank Ltd. “As the world re-emerged post-pandemic with acute monetary and fiscal issues, investing had to change - re-thinking portfolio construction and adapting to new market dynamics became more important than ever.”
This requires a change of mindset over what risk means in this new era of high inflation and interest rates. Spooked by the market turmoil over the past year, many wealth management clients have taken a no-risk approach to wealth preservation, cutting their exposure to risk assets across the spectrum and instead seeking the safety of cash. While waiting for the storm to pass might seem like a safe move in an inflationary environment, sitting on the sidelines for a prolonged period also means wealth erosion.
“The conversation we are having as advisers is ‘cash may look attractive now, but staying in cash is not a strategy,” says Khelifi-Arnulphy. “What we’re saying is, you can take market risk in this environment, but you need to be smarter than just having a passive investment strategy or just doing the same things that have worked over the past decade. Solutions are available now in both the bonds and equities markets.”
One strategy that’s likely to gain further traction in this environment is the rotation away from growth sectors - such as US tech stocks - and into so-called value sectors. These include utilities, consumer staples such as food and beverage businesses and telecoms companies.
“Those sectors typically do well as yields start rising and discount rates on future growth become much higher,” says Oisin O’Leary, a fund manager at EFG Asset Management. O’Leary delivers solutions to clients by actively investing in defensive companies globally and has a particular focus on the UK market.
In the coming years, investors will need to adapt to the external factors affecting how they evaluate their investment options and where growth and income can be derived.
“Quantitative easing is being unwound, while interest rates will likely remain at more historically normal levels. People are also going to have to learn to live with inflation again”, says O’Leary.
“That is going to warrant a higher allocation to value in portfolios in the future than asset allocators have done over the last decade,” he says. “The companies that have led over the last 10 years are not necessarily the ones that will be leading over the next 10 years as we move into this new regime.”
That doesn’t mean investors need to cut out growth stocks entirely, but it does mean adopting a more blended approach which hasn’t been the standard practice in recent years.
“You have to be a lot more selective,” Khelifi-Arnulphy continues. “Whilst you could have benefited from the growth trend even in passive strategies because everything was rising, today, it’s about getting the style, sector and company selection right. That is where specialists with robust selection processes like Oisin come in.”
“The time for passive investing has come to an end,” O’Leary adds. “As we move into a period of heightened uncertainty and rising market volatility, that is really the time where active managers can shine.” As equity volatility increases, active managers who are skilled bottom-up fundamental stock pickers and great risk managers will be primed to step up to the plate.
This backdrop also means equity income will become increasingly important as stock market growth slows. Home to a number of companies that have high-free cash flows and defensive balance sheets that would form the core of an equity income portfolio, the UK is a particularly attractive option as it is.
“The UK is the premium market in the world for dividend stocks,” he explains. “Investors are always hunting for yield, and you can get attractive 4%+ yields out of really strong, resilient businesses that should hold up earnings through market downturns or a recessionary scenario.”
Given that most constituents in the FTSE 100 are not dependent on UK consumers for their earnings, O’Leary reminds investors to disentangle the UK’s economic prospects from UK equities.
Most large-cap UK equities predominantly derive their revenues from international markets. It is important not to confuse the UK macro environment, which remains relatively weak, with the UK equity market, which last year was the best-performing developed market in the world, according to O’Leary. Recognising that distinction is crucial.
He also expects dividend payouts to remain healthy, even amongst more cyclical stocks, such as energy companies that have historically been more likely to reduce dividends during a downturn.
O’Leary says: “The world is still relatively supply constrained in terms of energy and will likely remain so given the lack of investment in recent years. Energy companies are currently generating huge cash flows and have strengthened their balance sheets, so dividends are very well covered this time round.”
Even in a world where the only certainty is uncertainty, investors still have options to put their money to work. “Working with advisers helps balance out risks and opportunities,” says Khelifi-Arnulphy.
For the last 30 years, EFG has been building portfolios for UK and international clients. Its teams of advisers have the local and global knowledge to advise clients during periods of uncertainty. She concludes: “Our advisers’ role is to have conversations with clients who may feel nervous about these ‘new’ market conditions. It is also their role to guide on how to enter or re-enter markets adapting to their needs. There is no set way for all. We start by listening and build their investments accordingly.”
EFG leads clients in the right direction, earns their trust and builds long-term relationships. Visit efginternational.com/uk to find out more