Equities versus bonds
Awareness of economic cycles is central to investing successfully across asset classes, says AXA’s Mark Beveridge.
Bond and equity prices react to many events by heading in opposite directions, although the rise in prices across both asset classes has been a feature of the post-crisis period. We asked Mark Beveridge, lead manager of the St. James’s Place Balanced Managed fund at AXA Investment Managers, about investing on both sides of the divide.
The cash and bond allocation within the fund is often described as an insurance policy against equity market volatility. How has this allocation changed in recent years?
Our view is that the best hedge against challenged equity markets is government bonds. Whilst equities and bonds can be positively correlated for periods, in crisis moments (such as the global financial crisis) asset prices move in opposite directions. Any threat to economic growth will drive equities lower whilst increasing appetite for the security of government bonds. The weighting within the bond and cash element of the St. James's Place Balanced Managed Fund has been relatively stable over time. It is not our intention to use the asset weighting in a tactical way; it is a strategic allocation. In the last few years there has been more activity within the bond allocation due to three major challenges: a politically uncertain environment; the reversal of quantitative easing; and the pursuit of unsynchronised monetary policies around the world.
What is the advantage of being able to invest across a range of sovereign bonds, rather than just UK gilts?
The philosophy is to be as unconstrained as possible, investing wherever we can achieve the best hedge against the risks of the equity market at the time. At the moment, different economies are at different stages of the economic cycle, meaning that monetary policy is not synchronised. This gives differing yields and differing prospects for total return outcomes. The capacity to invest outside of UK gilts allows us to manage significant changes in the macro and political environment, such as the emergence of a Jeremy Corbyn-led government.
What is the bigger threat to equity markets: low growth and potential deflation, or increased inflation and higher interest rates?
The biggest threat to equities is a deflationary world which, as has been demonstrated in Japan, creates a negative cycle for corporates and the broader economy. In long-term deflationary cycles, governments are caught in a trap and traditional monetary policies become impotent. A slower growth environment, as we have had for the last few years, is a positive environment for stock pickers. Higher inflation and higher rates imply higher growth, which is a positive environment for equities. Ultimately equities are real assets and their value rises as inflation increases.
Are the UK, US and Europe diverging in terms of their growth and interest rate outlook?
The increasing synchronisation in terms of economic growth has been a positive for the global economy. This year – for the first time this decade – all economies are growing, which can build momentum economically. However, the differing regions are at different points in the cycle and this informs our stock picking. The US is now mid/late-cycle, the UK mid-cycle and Europe early-cycle – the interest rate outlook reflects this.
As growth investors, are there any sectors or industries where you think investors are overpaying for growth or where earnings growth may disappoint?
Perversely, growth investing is quite well suited to markets where economic growth is scarce, as not all companies can grow, and the market differentiates strongly between the winners and losers. This a good phase for stock-picking approaches that have an accent on growth. The challenge for a growth manager will always be that successful growth businesses tend to become increasingly highly valued; you have to be extremely vigilant for warning signs of fundamental setbacks.
Within a balanced fund mandate, a key principle is that equities and sovereign bonds don't suffer heavy losses at the same time. Is there a scenario in which this relationship could break down, and what are the likely warning signs?
An environment of unexpectedly higher levels of inflation could pose problems for both equities and bonds. In this scenario, short term interest rates could rise sharply, leading to lower economic growth or even a recession, which would impact both asset classes. Equities would be impacted due to a reduced economic output and the prices of longer-dated bond would suffer due to the unforeseen rate rises. I don't believe we are heading in this direction.
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The opinions expressed are those of Mark Beveridge of AXA Investment Managers and do not constitute investment advice. This is not a recommendation to purchase, sell or subscribe to financial instruments, an offer to sell investment funds or an offer of financial services. This does not constitute a Financial Promotion as defined by the Financial Conduct Authority. No financial decisions should be made on the basis of the information provided. The views are not necessarily shared by other investment managers of St. James's Place Wealth Management.
Issued by AXA Investment Managers UK Ltd. Registered office 7 Newgate Street, London, EC1A 7NX. Registered in England no. 1431068.
Authorised and regulated by the Financial Conduct Authority.
21115 08 2017