As with every year it is important that we hold ourselves to account on our published views so, as we approach the end of 2022, it is time to reflect on the year that has been. (In January 2023’s Investor Insight, we will again publish our views and outlook for the year ahead).
In January this year, we published our Investor Insight 105, The Year Ahead, and we projected a theme for 2022: “where we believed that investors would be pleased, they have been exposed to risk-based assets however, it is going to be a bumpy ride.”
We mentioned that we did not believe we were in the “roaring twenties”, but we positioned ourselves overweight risk-based assets as we entered 2022. This was on the back of both manageable inflation and interest rates trending higher, but again at a manageable level.
Where we did provide caution was that interest rate expectations and inflation needed to be watched carefully as “they will indicate if we are to see rougher water ahead, and that headline watchers will take risk off the table at the slightest move, which is why we are expecting volatility”.
In summary we said, “our key message is to be prepared for volatility”, but as we look back to the beginning of this calendar year, we would not have envisaged that we would make eight tactical asset allocation changes over the year, starting just one month later, and to a position where we close out the year underweight risk-based assets.
The one thing we repeated often with confidence was that our returns in 2022 would not match those of 2021.
Volatility has been far higher than expected and markets in many respects have behaved in a bi-polar fashion, with nowhere to hide in many respects however, our relative performance and fund selection has seen client portfolios come through in very good shape, and we stand by our claim that “2022 will be the year where investment portfolios will see the benefit of asset allocation and diversification”.
We close out 2022 with the following tactical asset allocation positions:
FIXED INCOME
We commenced 2022 with an underweight allocation to domestic and global fixed income and a neutral credit allocation. We warned that fixed income would not provide the defensive characteristics that many investors expect and, given that Central Banks had clearly signalled that cash rates would be increasing during the year, floating rate or short duration fixed rate bonds were preferred.
This was the correct positioning and has saved our clients large losses from this asset class. We cannot, however, pretend to have forecast the size of the selloff in the bond markets this year. Indeed, we have seen the largest selloff in bond markets for over 40 years, as Central Banks raised rates further and faster than anticipated as inflation expectations soared.
The Fed Funds rate in the US started the year at 0-0.25 per cent, rising to 3.75-4.0 per cent currently, with a final increase for the year still to come. US 10-year Treasury Bonds rose from 1.50 percent to a peak of 4.25 per cent, before rallying over the last month to 3.65 per cent.
In Australia, the RBA cash rate started the year at 0.10 per cent, rising to 2.85 per cent currently, with a further increase likely next week. AUD 10-year Treasury Bonds rose from 1.30 percent to a peak of 4.30 per cent, before rallying over the last month to 3.55 per cent.
Whilst more cash rate increases have been signalled by the Central Banks, albeit at a softer pace, we have cautiously started adding some bond duration back into portfolios and end the year closer to a neutral position in fixed income.
EQUITIES
We entered 2022 with a marginal overweight position towards Developed Market Equities, favouring Developed Markets outside of the US, and this was predicated on the back of stronger earnings revisions out of Europe. We were neutral Australian Equities and Emerging Markets Equities.
How things changed.
The US equity market high during 2022 was recorded in the first weeks of January at approximately 4,800 on the S&P500, and a low of just under 3,500 was recorded towards the middle of October 2022, meaning US equity markets had retraced approximately 27% at their worst point. Domestic equities followed a similar pattern to offshore markets, although with less volatility thanks to our more value orientated market composition, with calendar year to date falls reaching 14% at their low points in late September.
Our marginal overweight position within Developed Market Equities was wound back to neutral in February and we used the first of three relief rallies in March to reduce further to a marginally underweight position at the end of calendar quarter one. We made one final tactical asset allocation change in September, moving to significantly underweight Developed Market Equities and remaining this way as we head into December.
Domestic and Emerging Market Equity changes were less pronounced, with our positioning remaining neutral for both asset classes for most of the year. This worked in our favour for Domestic Equities however a more favourable positioning would have been an underweight within Emerging Market Equities, as a twin COVID and Property market crisis in China and a war in Developing Europe weighed on Emerging Market Equities.
We remain significantly underweight Developed Market Equities and neutral Domestic and Emerging Market Equities at the end of 2022.
PROPERTY
We started 2022 with a moderate overweight Property allocation, including REITs.
Listed REITs are highly sensitive to changes in interest rates, and the dramatic ratcheting up of interest rate expectations during the year resulted in us removing our overweight position in February and then moving underweight in May, as the real yield on offer for REITs reduced following the uptick in government bond yields.
The improvement in REIT valuations in the second half of the calendar year and a view that real yields had found a resting place at close to 1% led us to remove this underweight position in July and remain neutral for the remainder of the year.
We commenced reducing direct unlisted office exposure towards the end of the year, where investment vehicles with liquidity allowed us to, as we anticipate a tougher commercial office market to present headwinds for the sector during 2023. We are not predicting large drawdowns in valuations; however, we do recognise that higher interest rates and increased recession probability have resulted in downgrades to forecasts for the sector.
We remain neutral property and REITs at the end of 2022.
ALTERNATIVE ASSETS
This is an asset class we have increased our focus on over the last couple of years.
Allocations have been selectively increased over the last five years.
We have ensured that risk within this asset class is managed by ensuring diversification within sub-asset classes and amongst both assets and vintages.
We do believe our portfolios saw returns cushioned and enhanced through these asset classes in 2022. Alternative assets reduced volatility and enhanced returns over the year.
There is a clear benefit in looking at diversification, including private assets in the areas of Property, Diversified Credit, Private Equity, and Infrastructure, where appropriate for a client’s risk appetite.
SUMMARY
We have usually dedicated the final edition of each year’s Insight to purely looking back, but this year we want to make an exception. 2022 has not been a normal year and we would like to explain our asset allocation as we head into the year end.
Source: Heuristic Investment Systems
As 2022 draws to a close, our portfolios are underweight risk-based assets, and we are looking as to when to deploy cash.
We have positioned portfolios based on the above scenario analysis, with the Fed maintaining a cash rate below 5 per cent, inflation expectations anchored around 2.5 per cent, a US long bond rate not greater than 4.5 per cent and downside to the S&P500 of between 5-15 per cent.
Whilst many are calling the end of the equity market correction, we are not in that camp and it is important to explain our positioning to come to the above scenario analysis.
- We are looking for global growth to slow to a little over 1.5 per cent in 2023 from an estimated 3.6 per cent in 2022.
- We believe inflation will fall sharply in 2023, due to commodity price inflation abating as well as core goods inflation.
- We see cash rates peaking in Australia at 3.85 per cent and then easing in the second half of 2023.
- Markets have not properly factored in disappointing corporate earnings, with a recession in the UK and Europe and a mild recession in the US (Australia will avoid a recession). There is therefore still downside to equity markets, with a target on the S&P500 of below 3,400.
- We see limited upside in US long bond yields, and they will therefore rally in 2023 as economic growth stalls.
We will go into the above in a lot of detail in our January Insight as we look to the year ahead.
We become anchored to the circumstances we are often in – or how the latest market performance affected us.
When we are in a bear market, we think it will last forever; likewise, a market that is booming.
Risk should therefore be rewarded medium term over defensive, but through a conservative lens as opposed to high beta exposure.
Successful investors never forget risk as a key component of strategy, and the need for prudent risk management. Looking towards 2023, we are attempting to expose portfolios to risk exposure upside through equities and alternative assets whilst balancing risk in portfolio construction.
At Hamilton Wealth Partners, we will always position client portfolios for a full market cycle and will not be distracted by short term “noise”. Underlying asset valuations and credit quality are important to consider but asset allocation is the key and investors who are bold when markets are out of line with valuations will achieve the best results. Therefore, the combination of manager selection combined with diversification through asset allocation, discipline and patience should ensure portfolio outperformance is delivered.
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