Investors seem to have been going through a bout of euphoria and to have moved into higher-risk investments since the beginning of the year.
Reasons for this might have been inflation pressures starting to recede and a recession that hasn’t yet manifested itself.
Looking at the most bought and sold mixed-asset funds of the first six months of the year, there have been more inflows into funds in the higher-risk IA Mixed Investment 40-85% Shares than into other sectors with higher bond exposure, which suffered outflows instead.
But is it the right time to be adding risk to portfolios? None of the three experts we asked thought so.
Darius McDermott, managing director of Chelsea Financial Services and FundCalibre, is seeing different signs in the market that suggest cutting risk, giving up a potentially higher performance in favour of more peace of mind.
“Given the negative outlook and the continual headlines around the cost-of-living crisis and the negative macro picture in the first six months of 2023, we've seen the total opposite of risk-on sentiment both at an industry level and within our own client base, with people actively moving out of equities to buy fixed income,” he said.
“In our range of funds, we've been trimming technology equities, which bounced up between 20% and 30%, and buying solid, lower-risk gilts and fixed income. This gives you decent returns at lower risk. You can get a better return elsewhere, but it's all about being risk-adjusted. Now you can get 6% to 7% in corporate bonds, and 4% in cash.”
Sam Buckingham, mixed-asset investment manager at abrdn, found the increased risk-on sentiment in line with the latest Bank of America global fund manager survey (which indicated that fund managers are the least bearish they have been since February 2022) but said it is not justified.
“Whether or not the Fed manages a ‘soft landing’ is one of the key drivers of risk sentiment at the moment. This ‘soft landing’ narrative for the US has been gathering momentum as we have seen resilient economic growth in tandem with inflation undershooting expectations,” he said.
Headline Consumer Price Index (CPI) in the US, at 3.2%, is now lower than Japan for the first time in eight years.
Concerns came from the rest of the world too, with growth deteriorating in the eurozone (the S&P Eurozone Manufacturing PMI is well into contractionary territory at 42.7) as well as in China, where the central bank had to unexpectedly cut interest rates this week in an attempt to boost growth.
“While the global economy has been more resilient so far than we expected, we remain cautious on risk assets, as leading broad economic indicators remain in recessionary territory, credit conditions are tight, and we are seeing substantial weakness in the manufacturing sector. Tightening cycles of this magnitude (and smaller) have historically almost always triggered recessions,” Buckingham continued.
“Our tactical asset allocation reflects the above concerns, remaining underweight equities and overweight government bonds. We don’t believe the full effects of the interest rate rises over the past 18 months have been felt in the real economy yet – nor do we think asset prices reflect them either.”
David Jane, multi-asset manager at Premier Miton Investors, agreed and recommended embracing prudence.
“We would normally be very happy with the easing liquidity conditions and this dramatic rally in the equity markets, were it not for the obvious risk that continued high interest rates and weak bond yields might suggest that we are not fully out of the woods. It is quite possible that further credit events will be unearthed by these tighter financial conditions,” he said.
Particularly worrisome to Jane was the seeming failure of Japan’s yield curve control program, the US commercial property market and its impact on the US regional banks, as well as the lending to Chinese residential developers.
“The reality is these things tend to creep up and then spiral out of control. The potential for a meltdown is there. That does not make it certain or likely, but we have to be prepared to act appropriately if things materialise,” he concluded.