In a similar spirit, a reflationary environment might be thought to favour equities but Sheldon MacDonald, deputy chief investment officer at Architas and manager of the group’s Blended range, thinks this may not be the case.
MacDonald is a believer in the reflation trade. He says: “We accept the general wisdom that the world is becoming a better place and inflation expectations are improving. While people are laying that at Trump’s door, the underlying conditions were there already in the form of stronger growth and lower unemployment.”
However, MacDonald does not share the prevailing wisdom that this will be good for equities. He says: “Valuations are certainly not cheap. They look reasonable relative to bonds but not on an absolute level, and the level of uncertainty gives us pause for thought. There is uncertainty in the US over Trump and what he will do.
“In Europe, populism is gaining traction: Marine Le Pen is looking a lot more electable. We also don’t know what shape or form Brexit will take. There are also uncertainties on corporate earnings. Valuations are currently discounting higher earnings and we need to see them start to come through.”
Ever the pragmatist
This means the Architas portfolios are underweight equities in general, and particularly in politically vulnerable areas such as the UK and Europe. This is in spite of some improving economic signs. The group sees better value in emerging markets and Asia, which lurched lower after Trump’s election in anticipation of anti-globalisation policies.
Certainly, president Trump has not toned down the rhetoric of his campaign since being in office but investors are realising there are limits to the damage he can do.
The US’s supply chains with Asia are complex and there is no evidence they can be replicated domestically in the US. MacDonald believes that, in the end, the global recovery will prove more important, benefiting these countries to a greater extent than Trump’s policies cause problems.
The recovering oil price should also be beneficial for exporters, while market valuations are still priced attractively, with potential for growth.
Having said that, where the Architas portfolios are invested in equities, MacDonald prefers funds with a value tilt. This is for pragmatic reasons: if there is a pullback in markets, valuation discipline is needed.
If MacDonald is not keen on equities, he is even more negative on fixed income. He says: “On the fixed income side we are underweight duration and have been underweight for some time. There are still plenty of government bonds trading at a negative yield. In spite of some uptick in yields, we still don’t see much value to be found in the government bond space.
“Certainly, the valuation argument has weakened as yields have risen and we are not as wedded to a short-duration stance looking ahead, but we still prefer to get our risk from credit, notably emerging market debt and high yield.”
If MacDonald doesn’t like fixed income or equities and they are not holding cash, where is the remainder of the portfolios invested? Architas has built specialist expertise to support the launch of the Architas Diversified Real Assets Fund, and the other portfolios also have higher weights in alternative and absolute return-style funds. This weight has increased in recent months.
MacDonald says: “These funds give us diversification and a decent yield, plus they provide a buffer against rising interest rates and inflation. Within the broader risk profile, we cherry-pick various areas from the Real Assets fund that are appropriate. This includes aircraft leasing or specialist lending, for example.”
Notably, however, it does not include equity long/short funds. He is unwilling to reduce the group’s underweight equity position further.
Virtuous circle
For the time being, although MacDonald sees inflation in economies, he is not overly concerned that it might go too far. For the time being, he sees a reasonably stable, steady level of inflation with the potential to create a virtuous circle: higher wages increase consumption, which creates demand for goods, which means companies employ more people.
The risk, to his mind, is that central bankers are behind the curve. Central bankers are more likely to err on the side of not raising rates because it is easier to tackle inflation than deflation – but the risk is that they leave it too long and inflation takes hold.
However, he does not believe there is much evidence to support this at the moment, nor is he looking to increase inflation protection, believing that equities provide sufficient protection.
The group offers both active and passive portfolios. For MacDonald’s part in the blended portfolios, he believes in using active funds in those areas that will give him the biggest bang for his buck.
“We believe they can deliver the most alpha or outperformance generally,” he says. “The potential for outperformance is higher in the equity space than in the bond space.
“As a result, our portfolio is tilted to passive on the bond side and we use a range of trackers to tilt the duration positioning. We take far more active risk in high yield and emerging market debt as these are the most inefficient areas.”
