Ignore the noise & stick to the strategy

Newton head of mixed assets investment Paul Flood explains why the multi-asset team is adding to bonds but cautious on duration.

The Newton multi-asset team is increasing exposure to bonds, namely UK gilts, but it remains cautious on duration on the expectation central banks will continue to raise interest rates to address high inflation.

Newton head of mixed assets investment Paul Flood thinks the bond bull market ended 10 years ago, and since then bond returns have been unattractive and offered a lack of diversification to equities.

However, Flood says the team has added to its bond exposure over the past few months after rising inflation led to a sell-off across the bond market. This sell-off, he adds, came after a long time of the bond market “living on borrowed time”. “At one point more than 30% of the global bond market was negatively yielding1,” he notes.

“It was a bit like Wile E Coyote running off the edge of a cliff: nobody really paid much attention until people looked down and saw there was a big inflation problem and that led to a sell-off in the bond market.”

Flood says in both the multi-asset growth and balanced strategies the team has been selling US Treasuries while adding to UK gilts. This, he adds, is because the difference between the UK government and US Treasury yield curves has moved closer in recent weeks as gilts have sold off. He thinks bond yields are likely to remain higher in the face of inflationary headwinds and geopolitical events.

Ongoing tension in US/China relations as well as the shift away from globalisation towards onshoring could increase prices of manufactured goods, says Flood, adding onshoring could result in higher costs as wages move higher, but it could also bring opportunities if the increasing uptake of automation brings down costs.

Flood does not expect inflation to persist at current levels for the next three years, but he thinks central banks are likely to continue raising interest rates to keep prices under control. This, he adds, will continue to impact the short end of the bond market, resulting in rising bond yields.

“While we are increasing our allocation to bonds, we are being careful within the multi-asset income and diversified return strategies that we don’t put too much emphasis on that duration or the sensitivity to interest rate movements because it is clear central banks are willing to push economies into recession to help keep inflation under control,” says Flood.

Alternatives

As a way of addressing inflation in portfolios, Flood says assets with higher exposure to alternatives are likely to hold up well and could provide an attractive level of yield relative to other asset classes. This, he adds, is because assets like infrastructure and renewable energy tend to have contractual inflation-linked revenue streams and as such, “have tended to do better in an inflationary backdrop”.

The energy transition theme also affords the opportunity to gain exposure to key commodities, including lithium, cobalt and copper, which are crucial for electric vehicles and renewables infrastructure, says Flood.

Another theme of interest is affordable healthcare which Flood says benefitted from a wave of innovation during the pandemic. He thinks this could lead to better and more efficient healthcare over the long term.

On the equities side, Flood says the multi-asset income team likes financials as they could stand to benefit from higher interest rates. Exposure to insurance companies is preferred over banks, and in particular health insurance where Flood thinks there are opportunities in the Asian market as higher per capita spending could feed through to life insurance policies.

"Assets with higher exposure to alternatives are likely to hold up well and could provide an attractive level of yield relative to other asset classes."