Multi-asset investors who obsess about trying to deliver a real return while inflation remains in double digits risk “disaster” for their clients, according to James Sullivan (pictured), fund manager and head of partnerships at Tyndall.
Last year’s spike in gilt yields led to these assets offering their highest rates in more than a decade. But while the current yield of 3.9% looks attractive in nominal terms, it represents a significant real-terms loss with CPI at 10.1%.
However, Sullivan warned that taking on more risk in an effort to keep up with short-term inflation figures could backfire spectacularly.
“A lot of folks are obsessed about the rate of inflation today being 9 or 10%, but what's really important is recognising that we invest for the medium to long term, typically a minimum of five years, then try to work out what the blended inflation rate is going to be over that period,” he explained.
“I think over-sweating the portfolio in pursuit of real returns will end in disaster. Just look at the long term and accept that there are going to be peaks and troughs.”
The manager said 2022 was the perfect example of why a long-term view is needed, as despite the “horrendous” sentiment in autumn when some investors were beginning to discuss cash as a viable asset class, the recent recovery means most indices are back in positive territory over 18 months.
Performance of indices over 18 months
Source: FE Analytics
He also claimed it underlined the importance of having a “rigid and objective” process to guide investors when they are at risk of allowing emotions to get in the way of decision making.
“As a community, we need to make sure that we remain committed to long-term objectives rather than to short-sighted views on these gyrations and volatility,” he added.
“I know this is cliched and people say it because they make money when their clients stay invested. But by moving in and out, it really interrupts the long-term cashflow forecast and the wealth creation mapped out for your clients over 10 to 15 years. The model doesn't allow for that behaviour.
“Our process is tried and tested over a long period of time, so we're not going to panic or make wholesale changes unless the process dictates it.”
In terms of asset allocation, Sullivan currently favours short-dated bonds over their longer-dated counterparts, noting there isn’t enough compensation for taking on duration risk. Where he is taking some fixed income risk is in high-yield bonds, where he said it is possible to get high single-digit yields on relatively short-dated instruments.
“The high-yield sector is already pricing in a default rate that is far higher than what has been witnessed in the past – a lot of bad news and then some,” he added.
When it comes to equities, Sullivan has always had a "valuation matters" principle and as a result continues to back UK cyclicals over areas such as US growth. While the former has rallied over the past six months and the latter has been in decline since it peaked towards the end of 2021, the manager said this trade still has a lot further to run.
Performance of indices over 5yrs
Source: FE Analytics
For example, he noted that while the US market fell by more than most other major markets last year, this was the first time this happened in more than a decade, “give or take”.
“One year in 10 doesn't then create an equilibrium or neutralise the overvalued market – you need more than that to really bring it into line with where it should be trading in the longer term,” he said.
“If you do believe in a reversion to the mean, we'll get two things: firstly, a further derating of growth stocks to bring valuations in line with their long-term average; and secondly, a narrowing of the valuation gap between value and growth that might come about because of a rerating of value.”
UK managers have claimed the value-oriented FTSE has looked cheap ever since the country voted to leave the EU. However, it has just become steadily cheaper. So what makes Sullivan think there will be a re-rating?
“Nothing in the short term, probably. But if inflation does stay in the system for longer, then the investment community is probably going to continue to demand shorter duration assets, which does lend itself to markets in Europe and the UK.
“I'd much rather be buying UK mid-caps today on single-digit P/Es and a low single-digit dividend yield than the North American growth market,” he finished.