November 15th, 2023
Prosser Knowles managed portfolio service (MPS) November update
Investor sentiment took a dip during the third quarter, as the growing belief that a “higher-for-longer” interest rate environment is now the more likely outcome weighed on stocks and bonds.
A resilient economic picture across the pond, an increased focus on the consequences of the large fiscal deficit, and the downgrade of the US’s triple-A rating by one of the major credit rating agencies all helped to undermine optimism, with a Central Bank pivot to lower rates appearing an increasingly distant prospect. This led to a weak quarter for bond markets, with the US 10-year yield rising over 0.75% and closing above 4.5% for the first time since 2007.
This rise in bond yields proved a headwind for equity markets too, as did heightened concerns regarding China’s property
market. Following a buoyant first half of the year, global equities posted a negative return over Q3, with August and September living up to their reputation as weaker calendar months for stocks.
The tech sector was the largest detractor, giving back some of the stellar gains posted in the first six months of the year, with consumer discretionary names also weighing on returns. At the headline level, growth stocks – the key driver of this year’s stock market gains – underperformed value, with energy stocks rising on the back of a rally in the oil price amid production cuts.
MPS strategy performance
Despite the weak end to the quarter for risk assets, the MPS strategy returns were broadly flat to positive over the period. This was driven by several factors:
- UK investors were largely shielded from international equity declines by currency movements, with GBP weakness/USD strength largely offsetting the falls posted by US stocks.
- UK equities also outperformed, with the market’s sizeable exposure to energy and mining stocks helping during a period of relative strength. We saw a return of just over 3.3% from the strategies’ UK allocation, outperforming the broader market.
- UK government bonds also fared better than their global counterparts. While the Bank of England did raise rates in August, there have been signs of slowing inflation which prompted the MPC to leave things unchanged in September. Expectations of a potentially lower ‘terminal rate’ in the UK has led to a rally in shorter-dated gilts, which delivered a positive return over the period. This was reflected by a gain of nearly 2% from our MI Quilter Cheviot Conservative Fixed Interest Fund, used to construct the lower-risk strategies’ bond exposure.
- Finally, we saw gains from the “alternative investment” funds (MI Quilter Cheviot Diversified Returns and MI Quilter Cheviot Alternative Assets) of between 1-2%, demonstrating the merit of these allocations in a period where equities and bonds fell in tandem.
To summarise, it certainly wasn’t a vintage quarter by any means, with security selection slightly weak across North America, Asia and emerging markets, in line in Europe and positive in the UK. However, most clients saw a modest gain on their investments over the period.
Recent weeks have been quieter for us in terms of strategy changes. We added modestly to Exxon Mobil as part of a review of our energy sector exposure. We also topped up our position in Palo Alto Networks, the US cybersecurity business, having trimmed the holding earlier in the quarter out of caution ahead of their Q4 results. The subsequent announcement reinforced our long-term conviction in the holding – an excellent performer year-to-date. These trades were funded through a modest reduction in our holding in chip manufacturer TSMC and the sale of our residual position in Disney, a disappointing performer since its reintroduction to the fund at the end of 2022. Despite the quality of the company’s brands, its traditional TV channels have seen meaningful sales and profitability declines. Coupled with a number of other challenges facing the company at this point in time, we have chosen to move on from the holding.
The feel-good factor seen for large swathes of 2023 has dissipated. While global stock markets are not expensive, with valuations broadly in line with long-term average, the latest upward leg in global bond yields has provided a headwind for further advances. After the strong gains seen in the first half, there is a sense that investors are waiting for an easing in this respect before they feel emboldened for another push higher.
With a lack of consistent direction in equity markets we continue to see this as a good environment for active stock selectors, remaining focused on incorporating the sector expertise of our research team, identifying the early opportunities but also the risks that are presenting themselves at the individual stock level. Moving away from stocks, we also think that fixed interest offers good value – sovereign debt in particular – while recession risks provide further support to the case for adding to headline government bond allocations and the duration of the exposure.
You can find out more about our MPS strategies, and how we executed them this September, on our YouTube channel.