A key part of our service is the rebalancing of our client portfolios when the need arises. After all, even long-term strategies can require amendments and the factors affecting global financial markets are unpredictable.
Our latest rebalancing aims to prepare our portfolios to perform in an environment of positive growth, albeit growth on a less significant scale than we saw in 2021.
Since we set about rebalancing our portfolios, tensions between Russia and Ukraine have escalated. Despite the escalation on the Ukraine borders, we think that market valuations already partially reflect geopolitical tensions. There are likely to be movements, but our long-term strategy remains the same and we are happy with our positioning.
Other risks for 2022 include rising inflation and changes to monetary policy in the US. After an initial correction, markets seem to have partially digested both. Monetary markets are already pricing in five hikes for 2022, while market volatility had started normalising before the situation worsened in Ukraine.
In Europe, on the other hand, the likelihood of monetary policy tightening remains low and markets expect only one hike this year. Overall, the Old Continent offers good opportunities for risky assets, thanks to both cheaper valuations and expansionary fiscal policies. As for the pandemic, Omicron proved to be less dangerous for the economy than previous variants.
We will be discussing our outlook for 2022 and beyond at our annual Strategic Asset Allocation event on February 22nd. We’ll also cover the situation around Ukraine and how it’s affecting our decision making. For full details and to register for the event, click here.
Lower risk portfolios
Our lower risk portfolios are made up more heavily of bonds than our higher risk products. For these, the most important global factors are metrics like inflation and the monetary policy moves of the major central banks.
For example, the change in expectations for US monetary policy was not enough to push us to make changes in the duration allocation of our portfolios. However, following signs that inflationary pressures in the US will begin to subside, we have reduced our exposure to inflation-linked bonds in the more conservative portfolios, given the lower risk of inflation surprises going forward.
Finally, for some of the more conservative risk profiles, we have reduced the investments in Investment Grade Bonds in order to increase the exposure to Chinese Government Bonds and Emerging Markets Debt, which show a better risk-return profile.
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Higher risk portfolios
Our higher risk portfolios are made up more heavily of equities. Now, looking at equity markets, after a year of very strong growth, valuations in the US look less attractive than Europe, the UK and Emerging Markets.
We’ve decided to factor this into our rebalance. Despite the market correction in early January, our analysis indicates that prospects for US outperformance remain low, mainly due to the risk that corporate earnings growth normalises. Japan’s prospects also look less favourable than other geographies, so we have decided to adjust higher-risk portfolios to underweight the US and Japan versus global equity. We have subsequently increased our weighting the UK and Emerging Markets as we see greater potential from a valuations standpoint.
On commodities, for these less conservative portfolios, we have cut our exposure to gold. This is predominantly due to the normalisation of US real rates, which have historically been highly correlated with the precious metal’s price.
Lastly, we have decided to invest in the broader commodity space. In addition to betting on a continued post-Covid economic recovery, commodities also represent a hedge against potential geopolitical risks that may emerge in the next months.
Socially Responsible Investing portfolios
When we rebalance our portfolios, our socially responsible portfolios are largely affected in the same way as our regular portfolios. There are, however, some specifics for investors to be aware of.
In this case, looking at equity markets, we see that valuations in Japan look less attractive than in Europe and Emerging Markets, but we do not see the same discrepancies between the US and European valuations. So, we have decided to adjust higher-risk portfolios to underweight Japan versus global equity.
As for fixed income, we have reduced the investments in Investment Grade Bonds in order to overweight the exposure to High Yield, which shows a better risk-return profile.
To express this view, we have added a new instrument (Lyxor ESG USD High Yield ETF) to some of our portfolios. The ETF invests in US High Yield Corporate debt, has an MSCI ESG score of AA and is currently free from any company not aligned with the United Nations Global Compact standards.
The environmental filters exclude firms that generate more than 5% of their revenue from thermal coal mining, power generation using thermal coal, or from unconventional oil and gas (or a mix of coal mining and unconventional oil and gas production), or any revenue from nuclear power generation.