During May, many asset sectors that comprise the components of the diversified funds performed well – both at the market level and in terms of excess returns provided by our active management. However, in aggregate it was only the Conservative fund which produced a positive return (0.44%) whilst both the Balanced and Growth funds fell slightly in value (-0.25% and -0.74% respectively). This is partly explained by the losses from our ‘alternative’ exposures to the Option Fund and the multi-strategy hedge fund, but mostly as a result of the losses suffered in the global equity markets. In fact, by the end of May 2019, global equity markets in aggregate posted a negative return for the 12 month period with only NZ dollar weakness enabling unhedged investors to generate a positive return from global equities, i.e. despite the underlying equities losing value, the value of the unhedged foreign currency increased against the NZ dollar enabling an overall positive return).
There were many reasons for the weakness in equity markets, and some of the key items are well covered – the ongoing uncertainties created by the US/China stand-off on trade, political tensions in the middle east, and uncertain growth in the Eurozone. As noted in last month’s commentary the local equity market remains remarkably strong rising another 1% in May and taking the 12 month return to 18%. This has certainly led to a number of companies here being bid up in price, but at the same time the behaviour observed is also quite rational with foreign capital searching for quality businesses that will generate strong cashflows and profit well above the yields offered by many other countries and sectors. It’s worth being mindful though of the time when some of that capital will be repatriated and the NZ market may lose some of the demand which has been creating these tailwinds for performance.
As is often the case, when equity markets suffer a loss of confidence from investors, the ‘safe-haven’ assets see a surge in demand and therefore increased prices. It was certainly true that sovereign bonds saw a strong price increase during the month as investors bid down yields, and so we observed bond markets providing returns to investors of well in excess of 1% for the month. It is this combination of the much higher than expected return from bond markets and the fall in global equities which led to the result of the more defensively positioned portfolios outperforming the more risk seeking portfolios for the month and indeed over the past 12 month period. This dynamic is to be expected from time-to-time, and those investors who have a longer term timeframe should still expect the more equity biased portfolios to outperform in the longer term, but in the meantime it’s been a period of strength for the more defensively positioned investors.
In the year to date, the NZ equity market has returned a quite remarkable 14% which is well ahead of any rational expectation. Having said that, we also shouldn’t be surprised that in a world hungry for yield, then good quality companies which can offer earnings growth above 5% p.a. and sustainable dividends at similar levels are going to be sought after. In particular, the so-called ‘bond proxy’ companies (e.g utilities) are attractive holdings for those who are prepared to accept additional capital risk for the desire/expectation of cash yields which are well ahead of traditional bank deposits and bonds. Last month we observed that there was talk of the global economy has passed the peak of this rates cycle, and this perspective may have gained weight with the New Zealand central bank having just cut interest rates.
But with economic data still reasonably robust it’s a slightly surprising approach, and our Governor was left explaining the move in terms of ‘getting ahead of the curve’, which seems to be a mild acknowledgement that current data maybe didn’t demand such a cut. Global equities performed particularly strongly during April, and with the weakening NZ dollar, those investors who were unhedged saw the value of their overseas equities increase by well over 5% during the month (hedged investors still enjoyed a 3% return). All the major markets contributed to these strong returns, but Germany led the charge (7%) whilst at the other end the UK was more modest, but still very strong, at 2% (noting that on average we’d expect around 0.5-0.75% over a month from our equity holdings). The developed markets continued to outperform their emerging market counterparts for the month, quarter and year.
April provided another strong set of returns for investors in the Nikko AM diversified funds. As has been the case since the start of the year, it has been equity markets that have driven these outcomes, but a slight change in April is that the bond markets were much weaker than they had been earlier in the year. Our exposures to alternative sources of return (the Nikko AM option fund and the fund of hedge funds strategy) performed well at around 2%, and so despite the weaker bond markets, the diversified funds again provided monthly returns significantly ahead of the long-term expectations. Within the diversified funds, we remain close to our benchmark weights which has the explicit effect of locking in some of the gains from the strong equity markets and we maintain the desired allocations across sectors and geography.
Emerging markets (EM) slid from February through the year-end on the back of a stronger dollar, an escalating trade war and notably weaker growth in China. However, we see evidence that these previous headwinds may now be turning into tailwinds.
The Japanese equity market fell in December, with the TOPIX (w/dividends) dropping 10.21% on-month and the Nikkei 225 (w/dividends) declining 10.28%.
It is a design fault amongst perhaps the majority of economists that, when things don’t quite go according to their forecasts, they will either ‘blame the data’ and stick to their previous view for too long, or attempt to finesse a ‘U-turn’ in such a way that it does not look like one so as not to undermine their short-term credibility….
Global growth is expected to grind lower in 2019, with continued monetary policy normalization in developed markets being the key headwind for the world economy. Financial conditions will tighten further as the Fed continues its gradual increase in interest rates.
In December, US Treasury (UST) yields fell as risk assets came under pressure from various factors, triggering ‘safe-haven’ buying.
The return of negative bond/equity correlations was a rare silver lining for multi-asset investors in 2018.
The MSCI AC Asia ex Japan (AxJ) Index fell by 2.6% in USD terms in December, as concerns about slowing global growth, tightening monetary policy and rising geopolitical tensions continued to drive sentiment.
The S&P/ASX 200 Accumulation Index returned -0.1% during December.