Bonds

Newton’s Paul Flood says the team has started adding to bonds recently, with several early data points pointing to an economic slowdown. The mixed asset portfolios are currently more balanced relative to the low weight to bonds they have held for the last five years. 

“We have a preference for gilts over Treasuries and to that end, recently sold short-dated inflation protected Treasuries as they had appreciated materially and moved into longer-dated nominal UK gilts,” adds Flood.

When it comes to interest rate sensitivity, the team has recently been selling short-dated government bonds in favour of longer-dated bonds. Flood sees this activity continuing throughout the year as they take time to build into positions.

“We believe that government bonds are attractive as they currently offer two things,” he adds. “First, they offer attractive yields above long-term inflation expectations. Second, they offer real diversification. You're now being compensated for taking on longevity risk, and with signs of economic growth deteriorating, bonds are becoming increasingly more attractive on a relative basis.”
 

Equities

When it comes to equities, Flood believes it is a good time to be more exposed to regions outside the US.

Like many, the mixed assets team is concerned by market concentration, especially when considering the US accounts for about 66% of the global equity market¹. The Magnificent Seven² make up about US$17 trillion worth of market cap and as a combined group are significantly larger than the individual market cap of certain countries around the world, including China, India and Japan, that have bigger populations than the US³.

“We've been considering this within the portfolio construction process to try and protect clients and diversify away from some of those risks within the US equity market, but also some of the valuations that we see in the US versus other markets.”

In terms of valuations, Flood adds the S&P 500 index is trading on average at just over 20 times earnings but if you look at the top 10 securities in the S&P 500, which includes the Magnificent Seven, this group is trading at about 30 times multiples⁴.

Furthermore, Flood notes how the top 10 stocks represent about 35% of the S&P 500 index which is a larger weight than during the tech bubble in the early 2000s, when the top 10 represented about 25%. It's a similar story today with the MSCI World index where the top 10 stocks represent about 25%⁵.

“To put that in context, those stocks represent about 10% of our Multi-Asset Balanced and Multi-Asset Growth portfolios,” adds Flood. “We believe this approach improves diversification and makes sure our clients aren't overly concentrated.”

Flood and the team have noticed signs of divergence between the US and European economies. The US economy excelled until recently thanks in part to economic stimulus through tax cuts and subsidies but is highly indebted. In the eurozone, by contrast, Flood says tighter policy, stricter rules around bank regulation, for example, have resulted in debt to GDP falling.

Additionally, Flood says with Germany looking to spend more on defence and changing its budget rules to allow more fiscal leeway. Taken together, he says perhaps that could lead to a prolonged rebalance between the US and global equity markets.

“So, we believe it's a good time to be overseas with our allocations outside of the United States,” he adds.

Over the past six to 12 months Flood says the team has been reducing its US growth allocation in favour of European options. But it believes technology companies should continue to perform.

Alternatives

After a strong 2022 for alternatives due to both equities and bonds selling off, the sector has been weaker of late, admits Flood. He believes this is due to three reasons:

1. The higher interest rate environment has driven investors’ capital towards bonds rather than alternatives.

2. Regulatory concern over cost disclosure of investment trusts has pushed up the ongoing costs figures and led capital toward fund structures instead.

3. The liability driven investment (LDI) crisis in September 2022 led to pension funds offloading risk assets, including alternatives, and buying more bonds to match their liabilities. 

But Flood believes there are key attractions to alternative assets. These include:

• The regulated nature of revenue streams providing the potential to gain insight over forward-looking returns
• Inflation-linked cash flows in a period of higher inflation. These assets can protect you in real terms like we saw in 2022.

Importantly, he notes these assets have attractive yields and therefore better forward-looking return potential. Flood explains that as bond yields rose through 2022 and into 2023/24 they offered an attractive option for investors which meant alternatives were overlooked. As such, higher discount rates were used to calculate net asset values (NAVs) which has increased the discounts on certain renewable infrastructure funds, offering investors an opportunity to lock in attractive real yields. 
 

“Renewable infrastructure funds that once traded at 10-20% premiums now trade at more than 30% discounts,” says Flood. “As shares prices declined, investment trusts offer large dividends, well covered, and high dividend yields.”

Flood also argues alternatives play an important diversification role in portfolios. He points to 2018 and 2022 which saw stable and robust returns from alternative assets when equity and bond markets were negative. “They are great diversifiers, particularly when inflation comes through higher than anticipated,” he adds.

The value of investments can fall. Investors may not get back the amount invested. Income from investments may vary and is not guaranteed.