At Seneca we have a five-year investment time horizon so our views don’t tend to change very often. I have little doubt that when I write my second piece in a month’s time, nothing will have changed as far as our asset allocation is concerned. I know a lot of funds chop and change every month. We don’t.
"The only way your return can be positive in real terms is if yields fall further"
That doesn’t mean we don’t have punchy positions in our portfolios, whether at an asset allocation or selection level. Quite the contrary. Low conviction for us means poor performance, as I believe it should for you.
So, I thought I’d use these two pieces to focus in on our high conviction asset allocation positions within our funds and explain to you why we hold them.
Apologies for not writing about the US presidential election or Brexit but to us they are just ‘noise.’ My asset allocation methodology is to gauge where various countries are with respect to their business cycle and to consider whether the yields of various markets and asset types look good value. Neither Brexit nor Trump play a role in this.
At a broad level, we are overweight equities and underweight bonds, particularly safe haven bonds (note that overweights and underweights are cited in relation to a fund’s strategic asset allocation).
Working backwards, this means that we think we are entering the later stages of business cycles when equities can continue to perform well but when long-term interest rates start to rise because inflation pressures are either stabilising or rising (the time to sell equities will be when employment growth turns negative but I think that is some way off, particularly in Europe).
Our reason for being underweight safe haven bonds – we don’t hold any! – is very simple: they are horrendously expensive. Looking at yields on inflation linked bonds – I prefer real yields because investors’ real returns are more important than nominal returns – the yield on the 30 year linker Gilt is currently -1.8%. This means that your annual return on investment will be whatever the inflation rate is less 1.8%. The only way your return can be positive in real terms is if yields fall further.
Now, with yields already at -1.8%, a level they’ve never been at before, can they go lower? If you hold safe haven bonds, and this goes for linkers as well as nominals, the question you need to ask yourself is, do you feel lucky? Well, do you, punk?!
We try not to rely on luck, so are happy to avoid them. It’s possible yields can go lower but we think it’s unlikely. The only way in my view that low or negative long-term real yields make sense is if we are going to enter a multi-year global economic depression. And that has to be unlikely given what governments and central banks can do to prevent such.
As for equities, although some countries’ business cycles are more advanced than others, we think there is still some way to go. The length of a particular business cycle tends to reflect the severity of the bust that preceded it. Given how serious the crash was in 2008 and 2009, the recovery will naturally be longer. Furthermore, equity market yields, while certainly not as attractive as they were five years ago, are still on the whole above historic averages. Bear markets rarely start until they are well below.
Published in Citywire
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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